Learning objectives

By the end of this chapter you should be able to:

• Explain the accounting equation and how it keeps the statement of financial position in balance.
• Apply debit and credit rules confidently to assets, liabilities, equity, income, and expenses, including contra-accounts.
• Record straightforward double-entry postings from narrative transactions, ensuring entries balance.
• Analyse how transactions affect profit, assets, liabilities, and equity, and explain the correction when errors occur.
• Identify common recording errors, correct them, and explain the impact on the financial statements.

Overview & key concepts

Double-entry bookkeeping records every business transaction with two equal and opposite postings: total debits must always equal total credits. This keeps the accounting equation in balance and creates a clear link from source documents (invoices, receipts, bank payments) to ledger accounts and financial statements.

Assets = Liabilities + Equity

A practical way to classify balances (exam-friendly):

• Assets are the resources the business uses (cash, inventory, equipment, and amounts customers owe).
• Liabilities are claims by outsiders (suppliers, lenders, tax authorities — amounts the business must settle).
• Equity is the owners’ residual claim — what would be left after liabilities are settled.

If you can answer two questions for any transaction — “what changed?” and “where did it come from / where did it go?” — you can keep the equation in balance.

The accounting equation

The equation is not something you “calculate at the end”. It must still hold after every transaction.

Example: buying equipment for £5,000 on credit:

• Equipment (asset) increases by £5,000
• Payables (liability) increases by £5,000

Both sides increase by the same amount, so the equation stays balanced.

Double entry

Each transaction has a dual effect. Examples:

• Receiving cash from a customer increases cash and increases equity through income (revenue).
• Paying rent decreases cash and decreases equity through an expense.

Debits and credits

A debit is posted on the left of a ledger account; a credit is posted on the right. Debits and credits are not “increase” or “decrease” by themselves — the effect depends on the account type.

A workable rule-set:

• Assets: debits increase, credits decrease
• Liabilities: credits increase, debits decrease
• Equity: credits increase, debits decrease
• Income: credits increase, debits decrease
• Expenses: debits increase, credits decrease

Normal balances and contra-accounts

Most accounts have a “normal balance” (the side they usually build on):

• Most asset accounts: normal debit balance
• Most liability, equity, and income accounts: normal credit balance

Some accounts are contra-accounts: they move in the opposite direction to their “parent” category, even though they relate to it. Examples:

• Allowance for doubtful debts: a contra-asset (credits build the allowance, reducing receivables)
• Drawings: often treated as a contra-equity account (debits increase drawings, reducing equity)

Cash vs credit transactions

A common exam error is mixing up when an item is recorded with when cash is paid or received.

• Cash sale: revenue and cash recorded now.
• Credit sale: revenue recorded now, cash later (creates a receivable).
• Credit purchase: expense/asset recorded now, cash later (creates a payable).

This is why profit and cash movement are not the same thing.

Operating expenses and accruals

Operating expenses are costs consumed in running the business (rent, utilities, advertising, wages). Typical patterns:

• Incurred but not yet paid: record the expense and a liability (accrual).
• Paid immediately: record the expense and reduce cash.
• Paid after being accrued: reduce the liability and reduce cash.

This applies the matching principle: expenses are recognised in the period they relate to, not when cash is paid.

Inventory and cost of sales

Inventory is usually recorded as an asset when purchased. Profit is affected when inventory is sold, because the related cost is recognised as cost of sales at that point.

In many questions, a sale has two effects:

1. record the sale (revenue and cash/receivable)
2. record the cost of the goods sold (cost of sales and inventory reduction)

If the question does not provide cost information, only the revenue side can be recorded, and the limitation should be stated.

Inventory system note (important)

This chapter uses a perpetual inventory approach (Inventory is updated on each purchase/return/credit note). In a periodic system, purchases are posted to a Purchases account and Inventory/Cost of sales are adjusted at the period end.

Deferred income (unearned revenue)

When a customer pays before goods/services are delivered, the business has an obligation to perform in the future. Until that performance occurs, the receipt is a liability, not revenue.

On receipt:

• Debit Cash
• Credit Deferred income (liability)

When the goods/services are provided:

• Debit Deferred income
• Credit Revenue

Notes payable and interest

A note payable is a formal borrowing agreement. The principal is a liability. Interest is recognised over time as it accrues.

If interest accrues but remains unpaid at period end:

• Debit Interest expense
• Credit Interest payable

When interest is paid:

• Debit Interest payable
• Credit Cash

Allowance for receivables that may not be collected

When you make credit sales, you record the receivable at the invoiced/transaction amount. Later, if some balances may not be collected, you do not wait for a customer to default before reflecting that risk. Instead, you record an expense and build an allowance that reduces receivables to a more realistic carrying amount.

Typical postings:

• Debit Bad debt / receivables impairment expense
• Credit Allowance for doubtful debts (contra-receivable)

Writing off a specific balance that is confirmed irrecoverable:

• Debit Allowance for doubtful debts
• Credit Receivables

This way, the loss is recognised once (when the allowance is built or increased), and the later write-off uses the allowance rather than creating a second expense.

Equity transactions (owner contributions, drawings/dividends, retained earnings)

Owner contributions increase equity but are not income. Owner withdrawals reduce equity but are not operating expenses.

Equity movement can be summarised as:

Closing equity = Opening equity + Owner contributions + Profit - Owner withdrawals/distributions

Core theory and frameworks

Recognition and measurement (practical exam focus)

In bookkeeping questions, recognition is usually driven by transaction evidence:

• supplier invoice received → record expense/asset and a liability
• sales invoice issued → record revenue and a receivable
• cash received/paid → record cash movement and the matching second entry

Measurement is normally at the transaction amount (invoice value or agreed price), unless the question specifies a different basis.

Borderline cases: capital vs revenue

A common source of errors is deciding whether a cost should be capitalised (asset) or expensed (profit or loss).

A useful distinction:

• Capital: creates or improves a resource used over more than one period (e.g., new equipment).
• Revenue: supports day-to-day operations or consumes benefits quickly (e.g., monthly rent, routine repairs).

Worked example

Narrative scenario

Greenfield Supplies carries out the following transactions during March 2026:

1. The owner invests £15,000 cash into the business.
2. The business purchases office furniture for £2,500 on credit.
3. It sells goods for £4,000, receiving cash immediately.
4. The business pays £1,200 for rent by bank transfer.
5. It purchases inventory costing £3,000, paying £1,000 in cash and the rest on credit.
6. The business receives a £500 utilities invoice, to be paid next month.
7. It pays £1,000 to a supplier, settling part of the amount owed from the credit portion of the inventory purchase.
8. The owner withdraws £800 cash for personal use.
9. The business earns £2,500 in revenue, with payment due next month.
10. It receives £1,000 from a customer as part payment against the £2,500 credit sale.
11. The business pays £300 for advertising expenses.
12. A supplier issues a £200 credit note relating to goods still held in inventory (the credit note reduces the amount payable).

Assume there are no opening balances on 1 March 2026.

Required

• Compute the closing balances for cash, payables, and equity.
• Prepare the journal entries for each transaction.
• Reconcile the cash account to confirm the cash balance.
• Identify any misclassifications and correct them.
• Describe the impact on the financial statements.

Solution

Journal entries and accounting equation impact

1) Owner invests £15,000 cash

• Debit Cash £15,000
• Credit Owner’s capital £15,000

Effect: Assets ↑ £15,000; Equity ↑ £15,000.

2) Purchase office furniture on credit (£2,500)

• Debit Office furniture £2,500
• Credit Payables £2,500

Effect: Assets ↑ £2,500; Liabilities ↑ £2,500.

3) Cash sale of goods (£4,000 received)

• Debit Cash £4,000
• Credit Revenue £4,000

Effect: Assets ↑ £4,000; Equity ↑ £4,000 via income.

Note: No cost information is given, so no cost of sales entry can be made in this question.

4) Pay rent by bank transfer (£1,200)

• Debit Rent expense £1,200
• Credit Cash £1,200

Effect: Assets ↓ £1,200; Equity ↓ £1,200 via expense.

5) Purchase inventory (£3,000), £1,000 cash and £2,000 on credit

• Debit Inventory £3,000
• Credit Cash £1,000
• Credit Payables £2,000

Effect: Assets ↑ £2,000 overall; Liabilities ↑ £2,000.

6) Receive utilities invoice (£500), payable next month

• Debit Utilities expense £500
• Credit Accrued expenses / Utilities payable £500

Effect: Liabilities ↑ £500; Equity ↓ £500 via expense.

7) Pay supplier £1,000 (part settlement of amount owed for inventory)

• Debit Payables £1,000
• Credit Cash £1,000

Effect: Liabilities ↓ £1,000; Assets ↓ £1,000.

8) Owner withdraws £800 cash

• Debit Drawings £800
• Credit Cash £800

Effect: Assets ↓ £800; Equity ↓ £800 (not an expense, so profit is unchanged).

9) Credit sale / revenue earned £2,500 (payment due next month)

• Debit Receivables £2,500
• Credit Revenue £2,500

Effect: Assets ↑ £2,500; Equity ↑ £2,500 via income.

10) Receive £1,000 from customer (part payment against receivables)

• Debit Cash £1,000
• Credit Receivables £1,000

Effect: Total assets unchanged (cash ↑, receivables ↓).

11) Pay advertising expense £300

• Debit Advertising expense £300
• Credit Cash £300

Effect: Assets ↓ £300; Equity ↓ £300 via expense.

12) Supplier credit note £200 for goods still held (perpetual inventory)

• Debit Payables £200
• Credit Inventory £200

Effect: Liabilities ↓ £200; Assets ↓ £200.

Explanation: the supplier credit note reduces the amount owed and reduces the recorded cost of inventory still on hand. Under a periodic system, the credit note would typically reduce Purchases (or be posted to Purchase returns).

Closing balances (cash, payables, equity)

Cash balance

Cash inflows:

• £15,000 (1) + £4,000 (3) + £1,000 (10) = £20,000

Cash outflows:

• £1,200 (4) + £1,000 (5 cash part) + £1,000 (7) + £800 (8) + £300 (11) = £4,300

Cash closing balance = £20,000 - £4,300 = £15,700

Payables and accruals balance

Liability increases:

• £2,500 (2) + £2,000 (5 credit part) + £500 (6) = £5,000

Liability decreases:

• £1,000 (7) + £200 (12) = £1,200

Payables and accruals closing balance = £5,000 - £1,200 = £3,800

Equity closing balance

Equity components:

• Capital introduced: £15,000
• Profit for March:
• Drawings: £800 (8)

Closing equity = £15,000 + £4,500 - £800 = £18,700

Accounting equation check (consistency test)

Assets at 31 March 2026:

• Cash: £15,700
• Receivables: £2,500 - £1,000 = £1,500
• Inventory: £3,000 - £200 = £2,800
• Office furniture: £2,500

Total assets = £15,700 + £1,500 + £2,800 + £2,500 = £22,500

Liabilities:

• Payables and accruals: £3,800

Equity:

• £18,700

Liabilities + equity = £3,800 + £18,700 = £22,500 (balances).

Cash account reconciliation (ledger-style)

Cash debits (receipts): £15,000 (capital) £4,000 (cash sale) £1,000 (collection)

Total debits = £20,000

Cash credits (payments/withdrawals): £1,200 (rent) £1,000 (inventory cash part) £1,000 (supplier payment) £800 (drawings) £300 (advertising)

Total credits = £4,300

Closing cash = £20,000 - £4,300 = £15,700 (agrees).

Misclassifications to watch for (and correct treatment)

• Drawings are not an operating expense: record as drawings (equity reduction, not profit reduction).
• The utilities invoice creates an accrual (liability) and an expense even though it is unpaid at month-end.
• Customer receipts usually reduce receivables; they are not additional revenue.
• Supplier credit notes reduce the cost of purchases (inventory here) and reduce the amount payable; they are not “other income”.

Impact on the financial statements (high-level)

• Statement of profit or loss: revenue £6,500; expenses £2,000; profit £4,500.
• Statement of financial position:

Common pitfalls and misunderstandings

• Treating drawings as an expense: drawings reduce equity and do not affect operating profit.
• Reversing debits and credits: decide the account type first, then apply the rule.
• Recording only one side: every entry must balance.
• Confusing cash timing with revenue/expense timing: invoices can affect profit without cash moving.
• Posting receipts to revenue instead of reducing receivables.
• Handling discounts incorrectly: supplier credit notes reduce purchase cost (inventory/cost of sales, or purchases under periodic), not revenue.
• Forgetting the equation check: comparing total assets to liabilities + equity quickly reveals many posting errors.

Summary

Double entry forces complete recording and keeps the accounting equation in balance:

Assets = Liabilities + Equity

By mastering debit/credit logic, normal balances, and the treatment of common transactions (cash vs credit, accruals, inventory, deferred income, receivables and allowances), you can trace how transactions flow into profit and the statement of financial position with confidence.

FAQ

Why is the accounting equation so important?

Because it is the built-in balancing relationship behind the statement of financial position. If transactions are recorded completely and correctly, total assets will equal total liabilities plus equity.

How do debits and credits work across different accounts?

Assets and expenses increase with debits. Liabilities, equity, and income increase with credits. Normal balances help you sense-check postings, and contra-accounts (such as allowances and drawings) move opposite to their parent category.

What mistakes happen most often?

Posting only one side, treating drawings as expenses, recording customer receipts as new revenue, and confusing invoices (credit transactions) with cash payments.

How does double entry improve accuracy?

Because every transaction must balance. Errors are easier to spot through reconciliations and by checking that assets equal liabilities plus equity.

How do transactions affect equity and profit?

Income increases profit and therefore increases equity. Expenses reduce profit and therefore reduce equity. Owner contributions increase equity but are not income. Drawings reduce equity but are not operating expenses.

Summary (Recap)

Double-entry bookkeeping records each transaction with two equal postings so that:

Assets = Liabilities + Equity

You applied debit/credit rules, distinguished cash and credit events, and checked that ledger balances reconcile and the equation balances.

Glossary

Accounting equation Assets = Liabilities + Equity The relationship that links the business’s resources to the claims on those resources by outsiders and owners.

Double entry A recording method where each transaction is posted twice (debits equal credits) so the records remain in balance.

Debit A left-side posting in a ledger account.

Credit A right-side posting in a ledger account.

Normal balance The side (debit or credit) where an account usually has its closing balance.

Contra-account An account linked to another account but with the opposite normal balance (for example, allowance for doubtful debts is a contra to receivables; drawings are often treated as a contra to equity).

Asset A resource used by the business (for example cash, inventory, equipment, receivables).

Liability An obligation the business must settle (for example payables, accruals, loans).

Equity The owners’ residual claim after liabilities are settled.

Income (revenue) Amounts earned that increase equity through profit.

Expense Costs consumed in the period that reduce equity through profit.

Receivables Amounts owed by customers from credit sales.

Payables Amounts owed to suppliers and other creditors.

Accrual (accrued expense) A liability recognised for an expense incurred but not yet paid.

Inventory Goods held for sale (or for use in production) recorded as an asset until sold.

Cost of sales The cost of inventory sold in the period, recognised as an expense when the related revenue is recognised.

Deferred income (unearned revenue) A liability recognised when cash is received before goods/services are delivered.

Allowance for doubtful debts A contra-receivable that reduces receivables to a more realistic amount expected to be collected.

Drawings Owner withdrawals from the business; they reduce equity and do not affect operating profit.

Ledger account A record that accumulates transactions for a specific item and shows the running balance.

Duality The principle that each transaction has two linked effects, so debits equal credits.

Learning objectives

By the end of this chapter, you will be able to:

• Explain how the accounting equation is kept in balance through double-entry bookkeeping.
• Apply debit and credit rules correctly to assets, liabilities, equity, income, and expenses.
• Record straightforward journal entries from transaction descriptions, ensuring debits equal credits.
• Post journal entries to ledger (T-) accounts, maintain running balances, and balance off accounts at the period end.
• Extract a trial balance and explain what it can and cannot prove about the accuracy of the records.

Overview & key concepts

Every accounting system is built on one idea: each transaction has two sides. When one account changes, another account (or accounts) must also change so that the records remain consistent.

That consistency is captured by the accounting equation:

Assets = Liabilities + Equity

Double-entry bookkeeping uses debits and credits to record both sides of each transaction so that the equation remains in balance. If debit/credit logic is applied consistently, the ledger balances can be summarised into a trial balance, and then developed into financial statements.

Debit and credit foundations

What “debit” and “credit” mean

• A debit (Dr) is an entry on the left-hand side of an account.
• A credit (Cr) is an entry on the right-hand side of an account.

Debit and credit are directions of entry. Their effect (increase or decrease) depends on the type of account.

The core rules (by account type)

Link the rules back to the accounting equation:

• Assets: increase with debits, decrease with credits
• Expenses: increase with debits, decrease with credits
• Liabilities: increase with credits, decrease with debits
• Equity: increase with credits, decrease with debits
• Income: increase with credits, decrease with debits

A quick equation check

After deciding your debits and credits, sense-check the effect:

• Does the entry keep Assets = Liabilities + Equity balanced?
• Can you describe what is increasing and what is decreasing?

Example (rent paid from bank):

• Bank (asset) decreases → credit bank
• Rent (expense) increases → debit rent expense

Journals: recording transactions before posting

A journal entry is a dated record showing:

• the accounts affected,
• which are debited and credited,
• the amount, and
• a short narration explaining the transaction.

Total debits must equal total credits for each journal entry.

Ledgers and T-accounts

What a ledger account shows

A ledger account records:

• transactions posted to that account (debits and credits), and
• the resulting balance at any point in time.

A T-account is a clear layout for a ledger: debits on the left, credits on the right.

Posting

Posting means transferring each line from the journal into the ledger:

• Debit in the journal → debit side of that ledger account
• Credit in the journal → credit side of that ledger account

Balancing off (c/f and b/f)

At period end:

1. total each side,
2. insert the balance c/f on the smaller side to make totals agree, and
3. bring the balance down next period as balance b/f on the opposite side.

Core theory and frameworks

Cash transactions vs credit transactions

Payment method determines whether you use cash/bank or receivables/payables:

• Cash sale: Dr Cash/Bank, Cr Sales
• Credit sale: Dr Receivables, Cr Sales
• Cash purchase/expense: Dr Expense (or asset), Cr Cash/Bank
• Credit purchase/expense: Dr Expense (or asset), Cr Payables

Operating expenses: expense vs asset

Most operating costs (rent, advertising, utilities) are expenses. Some payments create an asset first and become an expense later:

• Prepayment (paid in advance): Dr Prepayment, Cr Bank; later Dr Expense, Cr Prepayment
• Accrual (owed at period end): Dr Expense, Cr Accrued liability; later Dr Accrued liability, Cr Bank

Inventory and cost of sales: what gets debited?

Inventory is an asset until goods are sold. When goods are sold, the cost becomes cost of sales.

A common learning approach is to record purchases directly in Inventory:

• Purchase: Dr Inventory, Cr Bank/Payables

In this chapter’s worked example, inventory is recorded in this way to reinforce asset/liability movements. Cost of sales is not calculated or recorded here, so learners should not expect a second entry at the point of sale.

Deferred income (unearned revenue)

If cash is received before goods or services are provided, the receipt creates a liability until the obligation is satisfied:

• On receipt: Dr Bank, Cr Deferred income
• When earned: Dr Deferred income, Cr Income

Notes payable and interest: separating principal and finance cost

• On borrowing: Dr Bank, Cr Notes payable
• Interest accrual: Dr Interest expense, Cr Interest payable (or Cr Bank if paid immediately)
• Principal repayment: Dr Notes payable, Cr Bank

Receivables and the loss allowance (bad debt provision)

In practice, not every customer invoice is collected in full. To avoid overstating receivables and profit, businesses recognise an estimate of amounts that are unlikely to be recovered.

A simple introductory method is to maintain a separate loss allowance account that reduces the receivables figure presented in the statement of financial position.

To recognise or increase the allowance:

• Dr Impairment expense (receivables)
• Cr Loss allowance (contra to receivables)

To write off a specific debt (when an allowance is being used):

• Dr Loss allowance
• Cr Receivables

The key point is that the write-off removes the customer balance without creating a second expense, because the expected loss has already been recognised through the allowance. (At a higher level, this approach aligns with an expected credit loss model.)

Equity transactions: capital and drawings

For an owner-managed business:

• Capital introduced increases equity: Dr Bank, Cr Capital
• Drawings reduce equity: Dr Drawings, Cr Bank

Drawings are not an expense; they are a distribution to the owner.

Worked example

Narrative scenario

Consider a small retail business, ABC Retailers, which engages in various transactions during January 2026. The business starts the month with an opening bank balance of £5,000. Throughout the month, the following transactions occur:

1. Owner invests an additional £10,000 into the business bank account.
2. Pays rent of £1,200 from the bank account.
3. Purchases inventory worth £3,000 on credit.
4. Sells goods on credit for £4,500.
5. Receives £2,000 from customers as part payment of amounts owed.
6. Pays £1,500 to suppliers for previous credit purchases.
7. Withdraws £500 cash for personal use.
8. Pays £300 for advertising expenses from the bank account.
9. Receives a £200 refund for overpaid utility bills.
10. Sells goods for cash amounting to £1,800.
11. Pays £400 for office supplies in cash.
12. Receives £1,000 from a customer for a previous credit sale.

Required

• Prepare journal entries for each transaction.
• Post the journal entries to the relevant T-accounts.
• Balance the T-accounts and carry forward balances.
• Extract a trial balance at the end of January 2026.

Solution

Step 1: Journal entries

Opening balance (start of month) To reflect that the business already has £5,000 in the bank, there must be a matching equity interest:

• Dr Bank £5,000
• Cr Capital £5,000

Transactions during January 2026

Owner invests additional funds

• Dr Bank £10,000
• Cr Capital £10,000

Rent paid from bank

• Dr Rent expense £1,200
• Cr Bank £1,200

Inventory purchased on credit

• Dr Inventory £3,000
• Cr Payables £3,000

Goods sold on credit

• Dr Receivables £4,500
• Cr Sales £4,500

Cash received from customers (part settlement)

• Dr Bank £2,000
• Cr Receivables £2,000

Payment to suppliers

• Dr Payables £1,500
• Cr Bank £1,500

Cash withdrawn for personal use

• Dr Drawings £500
• Cr Bank £500

Advertising paid from bank

• Dr Advertising expense £300
• Cr Bank £300

Utility refund received If the refund relates to a prior overpayment and there were no utility charges recorded in the current month, it is clearer to present the refund as income rather than creating a “negative expense”.

• Dr Bank £200
• Cr Other income (utility refund) £200

Cash sale

• Dr Cash £1,800
• Cr Sales £1,800

Office supplies paid in cash

• Dr Office supplies expense £400
• Cr Cash £400

Receipt from customer for prior credit sale

• Dr Bank £1,000
• Cr Receivables £1,000

Step 2: Posting to T-accounts (with balancing)

Bank

Next period:

• Balance b/f (Dr) £14,700

Cash

Next period:

• Balance b/f (Dr) £1,400

Capital

Next period:

• Balance b/f (Cr) £15,000

Rent expense

Next period:

• Balance b/f (Dr) £1,200

Advertising expense

Next period:

• Balance b/f (Dr) £300

Office supplies expense

Next period:

• Balance b/f (Dr) £400

Inventory

Next period:

• Balance b/f (Dr) £3,000

Payables

Next period:

• Balance b/f (Cr) £1,500

Receivables

Next period:

• Balance b/f (Dr) £1,500

Sales

Next period:

• Balance b/f (Cr) £6,300

Other income (utility refund)

Next period:

• Balance b/f (Cr) £200

Drawings

Next period:

• Balance b/f (Dr) £500

Step 3: Trial balance at 31 January 2026

Interpretation of the results

The trial balance totals agree, which shows that postings are arithmetically consistent: total debit balances equal total credit balances. The business holds £14,700 in bank and £1,400 in cash. Receivables of £1,500 represent amounts still due from customers, while payables of £1,500 represent amounts still owed to suppliers.

Sales for the month total £6,300. Operating expenses recorded include rent, advertising, and office supplies. The utility refund is shown separately as other income, which keeps operating expense lines meaningful and avoids an expense account carrying a credit balance in a month with no utility charges recorded.

A balanced trial balance is an important check, but it does not guarantee that all transactions are complete or classified correctly.

Common pitfalls and misunderstandings

• Treating debits as “increase” and credits as “decrease” without classifying the account first: always identify the account type before applying debit/credit rules.
• Mixing cash and bank: “cash” means physical cash held; “bank” means amounts in the bank account. Record each transaction to the correct account.
• Omitting the opening double entry: an opening asset balance must be matched by opening equity and/or liabilities.
• Posting to the wrong side of a ledger: journal debits post to the debit side; journal credits post to the credit side.
• Assuming a balanced trial balance means no errors: omissions, wrong-account postings, and offsetting errors can still produce balancing totals.
• Confusing drawings with expenses: drawings reduce equity; they are not part of operating costs.
• Expecting cost of sales entries in every basic example: if cost of sales is not being calculated in the exercise, it will not be posted.

Summary and further reading

Debits and credits provide the mechanics that make double-entry bookkeeping work. By classifying accounts correctly and applying consistent debit/credit rules, transactions can be recorded in journals, posted into ledgers, balanced off, and summarised into a trial balance.

This foundation supports later topics such as inventory and cost of sales, period-end adjustments, receipts in advance, receivable impairment, borrowing and interest, and equity movements.

FAQ

Why are debits and credits confusing at first?

Because the words do not mean “increase” or “decrease” by themselves. Once you classify the account (asset, liability, equity, income, expense), the debit/credit behaviour becomes consistent.

How does a trial balance help in error detection?

It confirms whether total debit balances equal total credit balances, which helps detect one-sided entries and arithmetic mistakes. It will not reveal missing transactions or misclassifications.

What is the purpose of narrations in journal entries?

They explain the entry and support the audit trail. A short narration makes later review, correction, and tracing to source documents much easier.

Why must balances be carried forward?

Because the closing balance at the end of one period becomes the opening balance of the next, ensuring continuity in the records.

How do compensating errors affect the records?

Two errors can offset each other and still produce a balancing trial balance. This is why reconciliations and reviews of unusual balances are needed, even when the trial balance totals agree.

Summary (Recap)

This chapter explains how double-entry bookkeeping keeps the accounting equation in balance through debits and credits. It shows how to translate transactions into journal entries, post them to ledger (T-) accounts with proper balancing, and extract a trial balance. It also highlights common errors, particularly around account classification and the difference between cash and bank.

Glossary

Debit (Dr) An entry made on the left side of an account.

Credit (Cr) An entry made on the right side of an account.

Journal entry A dated record of a transaction showing the accounts affected, the debit and credit amounts, and a short narration.

Ledger account A record for one account showing all debits and credits posted to it and the resulting balance.

T-account A simplified ledger format, with debits on the left and credits on the right, used to show postings and balances clearly.

Posting Transferring amounts from the journal into the relevant ledger accounts.

Balance The net total in an account after offsetting debits and credits, shown as either a debit balance or a credit balance.

Carry forward (c/f) The balancing figure inserted at period end so both sides total the same; it represents the closing balance.

Bring forward (b/f) The opening balance of the next period, equal to the previous period’s carried forward balance.

Trial balance A list of ledger balances extracted at a point in time to check whether total debits equal total credits.

Narration A brief description included with a journal entry to explain the nature of the transaction.

Contra entry An entry recording movement between cash and bank (or between internal cash records), where the debit and credit are both within cash/bank-type accounts.

Normal balance The side an account typically carries when it holds a positive balance: assets and expenses normally debit; liabilities, equity, and income normally credit.

Learning objectives

By the end of this chapter, you should be able to:

• Explain why source documents are essential evidence for recording transactions and creating an audit trail.
• Select the correct book of prime entry for common business transactions and explain why each book is used.
• Apply debit/credit logic to post from books of prime entry to ledger accounts, including VAT where relevant.
• Prepare receivables and payables control accounts from period totals and reconcile them to lists of balances and supporting evidence.
• Prepare a bank reconciliation by updating the cash book for bank-only items and explaining timing differences.
• Identify and correct common misclassifications (cash vs credit, VAT, discounts, returns, and dishonoured receipts).

Overview & key concepts

A simple process map (how evidence becomes financial statements)

Source document → Book of prime entry → Ledger accounts → Trial balance → Financial statements

• The source document provides evidence.
• The book of prime entry records the transaction in the correct “bucket”.
• Ledger accounts collect and summarise the effect by account.
• The trial balance checks that double-entry has been applied consistently.
• Financial statements present performance and position.

Why source documents matter

A source document is the original proof that a transaction occurred and the details are correct (date, amount, parties, terms, tax). Examples include sales invoices, supplier invoices, credit notes, receipts, remittance advices, till rolls, bank statements, payroll summaries, petty cash vouchers, and goods received notes.

Together, the documents and the accounting entries form an audit trail—a chain that allows a user to trace a figure in the accounts back to evidence (and trace the evidence forward into the accounts).

The accounting equation and transaction logic

Every entry must keep the accounting equation in balance:

Assets = Liabilities + Equity

Income and expenses are recorded during the period and ultimately affect equity:

• Income increases equity (through profit).
• Expenses decrease equity (through profit).

Debits and credits (practical rules)

Focus on what increases and what decreases:

Assets

• Increase: Debit
• Decrease: Credit

Liabilities

• Increase: Credit
• Decrease: Debit

Equity

• Increase: Credit
• Decrease: Debit

Income

• Increase: Credit
• Decrease: Debit

Expenses

• Increase: Debit
• Decrease: Credit

“Cash” vs “credit” (what the words really mean)

In bookkeeping, cash usually means immediate settlement to cash or bank (including card receipts that settle directly to the bank). It does not necessarily mean notes and coins. A credit transaction creates a receivable or payable first; cash/bank moves later when it is settled.

Core theory and frameworks

Source documents: three practical checks

Source documents help you check three practical things:

1. Reality: the transaction genuinely took place and relates to the business.
2. Measurement: quantities, prices, and tax have been calculated correctly.
3. Recording: it has been posted to the correct account and the correct period.

Books of prime entry (BPE): where transactions are first recorded

Books of prime entry organise transactions so they can be posted efficiently to ledgers.

Common books and what they capture:

• Sales day book: credit sales invoices only (not cash/card sales).
• Sales returns day book: customer credit notes (returns/allowances).
• Purchases day book: credit purchase invoices only.
• Purchases returns day book: supplier credit notes.
• Cash book: money in and out of bank (and sometimes a separate cash column for notes/coins).
• General journal: items not suited to the day books (opening entries, accruals, depreciation, bad debts/allowances, corrections, transfers).

Posting to ledger accounts

After recording in the books of prime entry:

• Totals from day books are posted to the general ledger (for example, total credit sales to revenue).
• Individual customer/supplier entries are posted to the receivables and payables ledgers.

VAT handling

Net, VAT, and gross

When VAT applies:

• Sales invoices typically show net + VAT = gross.
• Purchases invoices typically show net + VAT = gross.

The accounting records usually keep VAT separate:

• Output VAT on sales: liability (until paid to the tax authority)
• Input VAT on purchases: recoverable (or offsets output VAT)

VAT fraction (for VAT-inclusive figures)

If an amount is VAT-inclusive, extract VAT using the fraction:

VAT fraction = rate / (100 + rate)

Example at 10% VAT:

• VAT = gross × 10/110
• Net = gross × 100/110

Common transaction patterns and correct journal entries

Credit sale (invoice issued)

• Dr Trade receivables (gross)
• Cr Sales revenue (net)
• Cr VAT payable (output VAT)

Cash/card sale (immediate settlement)

• Dr Bank/Cash (gross)
• Cr Sales revenue (net)
• Cr VAT payable (output VAT)

Credit purchase (inventory or expense)

• Dr Inventory (or expense) (net)
• Dr VAT receivable (input VAT)
• Cr Trade payables (gross)

Sales returns (customer credit note)

• Dr Sales returns / Revenue reduction (net)
• Dr VAT payable (output VAT reduction)
• Cr Trade receivables (gross)

Dishonoured cheques (customer receipt reversed by bank)

Two effects are common:

1. The bank reverses the receipt:
2. The bank charges a fee:

Settlement discounts (discounts taken on payment)

Settlement discounts are recorded only when payment is made and the discount is actually taken.

Discount allowed (given to customer):

• Dr Bank (amount received)
• Dr Discount allowed (expense)
• Cr Trade receivables (amount cleared)

Discount received (from supplier):

• Dr Trade payables (amount cleared)
• Cr Bank (amount paid)
• Cr Discount received (income)
• (Alternatively, discount received may be presented as a reduction of related costs, depending on policy and materiality.)

VAT and settlement discounts (exam technique) Follow the question instruction. Some questions require VAT to be reduced in proportion to the settlement discount; others tell you to ignore VAT on settlement discounts.

Optional illustration (VAT-adjustment variant) A supplier invoice is gross 1,100 at 10% VAT (net 1,000, VAT 100). A 2% settlement discount applies to the gross amount (discount 22). VAT reduces by 2 (10% of net discount 20), and the remaining 20 is discount received.

On payment (VAT-adjustment variant):

• Dr Trade payables 1,100
• Cr Bank 1,078
• Cr VAT receivable 2
• Cr Discount received 20

Control accounts

A control account is a summary account representing the total of many individual customer or supplier accounts. It provides a check that postings are complete and accurate by comparing:

• the control account balance, and
• the total of individual balances from the receivables/payables listings.

Cash book and bank reconciliation

Two-stage approach

1. Update the cash book for items on the bank statement not yet recorded internally (bank charges, interest, standing orders/direct debits, dishonoured items, bank errors).
2. Reconcile the updated cash book balance to the bank statement balance using timing differences (outstanding lodgements and unpresented payments).

Only stage 1 changes the ledger balance. Stage 2 explains differences.

Petty cash imprest (controlled small payments)

Under an imprest system:

• A fixed float is set.
• Small payments are supported by vouchers.
• At replenishment, the float is topped back up to the fixed amount.

Payroll documents (gross pay, deductions, net pay)

Payroll records usually show:

• Gross pay (wages expense)
• Employee deductions (amounts owed to authorities/other parties)
• Net pay (cash paid to employees)

A simple set of entries:

• Dr Wages expense (gross)
• Cr Payroll liabilities (deductions)
• Cr Bank (net pay)

Drawings of goods (owner withdrawals)

Goods taken by the owner are not an expense. They are a withdrawal of value by the owner and reduce equity. In some bookkeeping systems (especially where purchases are accumulated during the year), drawings of goods may be recorded by reducing purchases; the key outcome is that profit is not understated and equity is reduced.

Worked example

Narrative scenario

ABC Retail is an unincorporated retail business. During December, the opening balances were:

• Trade receivables: USD 50,000
• Trade payables: USD 30,000

VAT is charged at 10%.

The following transactions occurred during the month:

1. Sold goods on credit for USD 20,000 (net) plus VAT.
2. Received a customer cheque for USD 15,000, which was later dishonoured by the bank.
3. Purchased inventory on credit for USD 10,000 (net) plus VAT.
4. Settled a supplier invoice with a gross balance of USD 5,000 and received a 2% settlement discount (cash paid USD 4,900). Assume VAT is not adjusted for the settlement discount.
5. Recorded sales of USD 8,000 (VAT-inclusive), made up of:
6. Banked USD 3,500 of the cash takings; USD 500 was retained as a cash float.
7. The card provider settled the gross card receipts (USD 4,000) into the bank. Merchant fees of USD 1,000 were charged separately.
8. Issued a customer credit note for returned goods of USD 2,000 (net) plus VAT.
9. Paid wages of USD 3,000; employee deductions were USD 500.
10. Reimbursed petty cash expenses of USD 200 from the bank.
11. Recorded drawings of goods at cost of USD 500.
12. The bank statement included a bank charge of USD 50 not yet recorded in the cash book.

Required

• Compute the VAT payable for the period.
• Prepare the trade receivables control account.
• Prepare the trade payables control account.
• Reconcile the cash book with the bank statement (updating the cash book for bank-only items).
• Identify and correct any misclassifications in the draft records.
• Describe the impact on the financial statements.

Solution

1) VAT payable for the period

Output VAT (sales)

Credit sale (net stated):

• Output VAT = 20,000 × 10% = 2,000.00

Total retail sales (VAT-inclusive):

• Output VAT = 8,000 × 10/110 = 727.27
• Net retail sales = 8,000 × 100/110 = 7,272.73

Sales return (credit note, net stated):

• Output VAT reduction = 2,000 × 10% = 200.00

Input VAT (purchases)

Credit purchase of inventory (net stated):

• Input VAT = 10,000 × 10% = 1,000.00

Net VAT payable

VAT payable = Output VAT − Input VAT = (2,000.00 + 727.27 − 200.00) − 1,000.00 = 1,527.27

VAT payable (liability): USD 1,527.27

2) Trade receivables control account (running balance format)

Closing trade receivables: USD 69,800

3) Trade payables control account (running balance format)

Closing trade payables: USD 36,000

4) Cash book update and bank reconciliation

Stage 1: Update the cash book for bank-only items

The bank charge of USD 50 appears on the bank statement but was not yet recorded.

Entry to update the cash book:

• Dr Bank charges expense 50
• Cr Bank 50

Stage 2: Updated bank (cash book) position for the month

Bank receipts

• Customer cheque received: 15,000
• Cash banked: 3,500
• Card receipts settled to bank (gross): 4,000

Total receipts = 22,500

Bank payments

• Dishonoured cheque (bank reversal): 15,000
• Supplier payment: 4,900
• Merchant fees: 1,000
• Wages paid (net): 3,000
• Petty cash reimbursement: 200
• Bank charge: 50

Total payments = 24,150

Closing bank balance (overdraft) = 22,500 − 24,150 = (1,650)

So, the updated cash book shows a bank overdraft of USD 1,650.

Bank reconciliation statement (what can be concluded from the information given)

With no bank statement closing balance and no timing differences provided (such as outstanding lodgements or unpresented payments), the focus here is the cash book update and the correct treatment of bank-only items. In a full question, you would compare the updated cash book balance to the bank statement balance given and list any timing differences needed to reconcile the two.

Cash in hand The cash float retained is USD 500, which remains as cash-in-hand (an asset) and is separate from the bank balance.

5) Misclassifications and corrections (high-impact checks)

• VAT on VAT-inclusive sales: VAT must be extracted using the VAT fraction (rate ÷ (100 + rate)), not calculated as a simple percentage of the gross.
• Dishonoured cheque: a dishonour reinstates the receivable and reverses the bank receipt; it is not a “deduction” from receivables in the period totals.
• Cash vs bank movement: cash banking is a transfer from cash-in-hand to bank. It does not create additional sales.
• Settlement discount clearing: a supplier balance of USD 5,000 gross is cleared by USD 4,900 cash plus USD 100 discount received (and VAT treatment follows the question instruction).

6) Impact on the financial statements (high level)

Profit or loss (performance)

• Revenue includes:
• Expenses include:
• Discount received 100 is recorded as other income (or as a reduction of related costs, depending on presentation policy).
• Drawings of goods 500 are not an expense; they reduce equity.

Financial position (statement of financial position)

• Trade receivables close at 69,800 (gross).
• Trade payables close at 36,000 (gross).
• VAT payable is 1,527.27 (liability).
• Bank is an overdraft of 1,650 (liability if presented as overdraft).
• Payroll deductions 500 create a liability until paid.
• Cash-in-hand includes the USD 500 float (asset).

Common pitfalls and misunderstandings

• Treating VAT as part of revenue/expense rather than separating it into VAT control accounts.
• Calculating VAT incorrectly on VAT-inclusive figures (forgetting to use the VAT fraction).
• Recording a dishonoured cheque as a receipt reduction without reversing the bank entry and reinstating the receivable.
• Confusing cash-in-hand with bank: banking cash is a movement between assets, not income.
• Posting credit sales into the cash book (credit sales belong in the sales day book and receivables ledger).
• Omitting settlement discounts or posting them to the wrong side (discount allowed is an expense; discount received is income or cost reduction).
• Mixing up returns: credit notes reduce the customer balance and reduce revenue (and output VAT).
• Building control accounts from individual invoices instead of using period totals and then reconciling to listings.
• Performing a bank reconciliation without first updating the cash book for bank-only items.
• Recording wages using net pay only (gross expense and deductions liabilities must be recognised).
• Treating drawings as an expense rather than as a reduction of equity.
• Forgetting that receipts in advance are liabilities until the goods/services are provided.

Summary and further reading

Accurate bookkeeping starts with reliable evidence. Source documents support each transaction and create a clear audit trail. Books of prime entry organise transactions efficiently before posting to ledgers. Control accounts provide an accuracy check over receivables and payables, while bank reconciliation ensures bank balances in the records match external evidence once cash book updates and timing differences are properly handled.

To strengthen exam performance, practise:

• identifying the correct book of prime entry from a set of documents,
• extracting VAT from VAT-inclusive amounts,
• preparing control accounts from period totals, and
• updating the cash book before reconciling to the bank statement.

FAQ

What is the role of source documents in accounting?

They provide evidence for each transaction and support accurate recording. They also make it possible to trace amounts in the records back to what actually happened.

How do books of prime entry differ from ledger accounts?

Books of prime entry record transactions first in grouped form (for example, all credit sales invoices). Ledger accounts then collect postings by account to show totals and balances.

What is the importance of control accounts?

They summarise receivables or payables and provide a check that postings to individual accounts are complete and accurate by comparing the control balance to the total of individual balances.

How is a bank reconciliation performed?

First update the cash book for bank-only items not yet recorded. Then compare the updated cash book balance with the bank statement balance and list timing differences that explain any remaining difference.

What are settlement discounts and how are they recorded?

They are reductions for early payment and are recorded only when taken. Discount allowed is an expense; discount received is income (or a reduction of related costs). If the question requires it, VAT may also be adjusted proportionately when the discount is taken.

What is deferred income and why is it shown as a liability?

If you receive money before you deliver the goods or service, you haven’t earned it yet. Until you supply what was promised, the amount represents an obligation to the customer, so it is shown as a liability. When delivery happens, you move it from the liability to revenue.

How are dishonoured cheques handled?

A dishonour reverses the bank receipt and reinstates the receivable. Any bank charges are recorded as expenses.

Summary (Recap)

This chapter explained how source documents feed into books of prime entry, then into ledger accounts, before producing a trial balance and financial statements. It reinforced debit/credit logic using the accounting equation, clarified cash versus credit transactions, and showed how VAT is separated from revenue and expenses (including how to extract VAT from VAT-inclusive amounts). It also covered control accounts as a completeness check and bank reconciliation as a two-stage process: update the cash book for bank-only items, then reconcile using timing differences. The worked example integrated these techniques by calculating VAT payable, preparing control accounts in a clear running-balance format, and aligning bank movements with cash and card sales.

Glossary

Source documents Original evidence of a transaction’s details (date, amount, parties, terms, tax), used to support entries and create a traceable record.

Audit trail A traceable link from source evidence through books and ledgers to reported figures (and back again).

Books of prime entry First-stage records that collect similar transactions before posting to ledgers.

Ledger accounts Records that accumulate transactions by account to show totals and balances.

Control account A summary account representing the total of many individual balances, used to check completeness and accuracy.

Bank reconciliation A statement that explains the difference between the updated cash book balance and the bank statement balance, usually due to timing differences.

Settlement discount A reduction granted for early payment. Recorded when taken; VAT treatment follows the question instruction.

Dishonoured cheque A receipt reversed by the bank; it reinstates the receivable and may create bank charges.

VAT (Value Added Tax) A transaction tax recorded separately: output VAT arises on sales, input VAT arises on purchases; the net is payable or recoverable.

Petty cash imprest A controlled system where a fixed petty cash float is maintained and replenished based on vouchers.

Deferred income Cash received before goods/services are supplied; recorded as a liability until earned.

Drawings Owner withdrawals (cash or goods) that reduce equity rather than being treated as an expense.

Merchant fees Charges by payment processors for handling card receipts, recorded as an expense and typically paid from the bank.

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):

1. Issued sales invoice S101 to Customer X: goods £2,000 + VAT £400 = £2,400 (credit).
2. Received purchase invoice P201 from Supplier Y: materials £1,000 + VAT £200 = £1,200 (credit).
3. Issued credit note CN10 to Customer X for a return: £200 + VAT £40 = £240.
4. Paid Supplier Y by bank transfer: £800 (part payment).
5. Received bank payment from Customer X: £1,200.
6. Recorded monthly depreciation: £500.
7. Corrected an error: invoice S102 had been posted to the wrong customer in the receivables ledger.
8. Recorded a bank charge: £50.
9. Bank statement shows interest received: £30.
10. 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)

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)

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)

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.

Learning objectives

By the end of this chapter you should be able to:

• Explain why journals (day books) are used as the first stage of recording routine transactions and how they fit into the accounting cycle.
• Distinguish between cash and credit transactions and select the correct book of first entry for each.
• Record sales returns using credit notes and post them to Sales Returns and Trade Receivables.
• Account for settlement discounts by calculating the discount, recording the cash movement, and recognising the discount in the ledger.
• Prepare correcting entries for common errors, including mispostings and reclassifications, so that ledger balances and financial statements are reliable.

Overview & key concepts

Businesses typically process large numbers of repetitive transactions: sales, purchases, receipts and payments. Journals (often called day books) organise these routine transactions into separate lists before posting them to the ledger.

This approach achieves three practical benefits:

• Efficiency: similar transactions are recorded in a consistent format and posted in batches.
• Accuracy: categorising transactions reduces posting mistakes and improves consistency.
• Audit trail: source documents (invoices, receipts, credit notes) can be traced from the journal to the ledger.

Journals do not replace double entry. They are a structured method of capturing transactions before they are posted into ledger accounts, where balances are maintained.

Purpose of journals and day books

A journal/day book is a book of first entry used to record transactions in date order and by type. The main journals are:

• Sales Journal (Sales Day Book)
• Purchases Journal (Purchases Day Book)
• Sales Returns Journal
• Purchases Returns Journal
• Cash Book (often split into Cash Receipts and Cash Payments sections, or presented as a columnar cash book)
• General Journal (for adjustments and non-routine entries)

Books used for routine transactions

Sales Journal (credit sales of goods)

Use the Sales Journal for credit sales of goods made in the normal course of trade.

Typical posting to the ledger:

• Debit: Trade receivables
• Credit: Sales revenue

Cash sales are not recorded here (they go in the cash book).

Purchases Journal (credit purchases: goods and often credit expenses)

Use the Purchases Journal for invoices received on credit. In many bookkeeping systems (and in many exam questions) this includes:

• credit purchases of goods for resale, and
• regular credit expenses/services (for example, carriage inwards, utilities, rent, repairs), often analysed into columns.

Purchases of non-current assets on credit are commonly kept out of the Purchases Journal and recorded through the General Journal (or a separate asset register), depending on how the bookkeeping system is designed.

Typical postings to the ledger (depending on what was purchased):

• goods for resale: Dr Inventory (or Purchases) / Cr Trade payables
• credit expenses: Dr relevant expense / Cr Trade payables

Cash book (cash and bank inflows and outflows)

Cash and bank movements are recorded in the cash book. In many bookkeeping systems, the cash book is both:

• a book of first entry (recording receipts and payments from source documents), and
• the ledger account for bank/cash (especially where a columnar cash book is used).

Because it also functions as a ledger, the cash book may include entries such as contra transfers (for example, moving cash from till to bank), where the debit and credit are recorded within the cash book columns.

Cash Receipts section (cash and bank inflows)

Use this section for all money received, whether from customers, loans, asset sales, or other sources.

The credit entry depends on the source of the receipt, for example:

• cash sale: credit Sales revenue
• receipt from a customer: credit Trade receivables
• bank loan received: credit Loan payable
• advance payment from a customer: credit Deferred income (unearned revenue)

Cash Payments section (cash and bank outflows)

Use this section for all money paid out, including supplier payments, expenses, asset purchases, and loan repayments.

The debit entry depends on what the payment relates to, for example:

• supplier payment: debit Trade payables
• utilities paid: debit Utilities expense
• equipment purchased for cash: debit Property, plant and equipment
• loan repayment: debit Loan payable (principal portion) and debit Interest expense (interest portion)

Sales Returns Journal (returns inwards / credit notes to customers)

Use the Sales Returns Journal for sales returns on credit and credit notes issued to customers.

Typical posting to the ledger:

• Debit: Sales returns (a contra-revenue account)
• Credit: Trade receivables

This reduces the amount owed by the customer and records returns separately from sales.

Purchases Returns Journal (returns outwards / supplier credit notes)

Use the Purchases Returns Journal for returns to suppliers on credit and supplier credit notes.

The posting depends on the inventory system and how purchases are recorded:

• Periodic approach (common in basic bookkeeping):
• Perpetual inventory approach (where inventory is updated continuously):

Using a purchases returns account in a periodic system keeps purchases and returns transparent.

General Journal (non-routine entries and adjustments)

Use the General Journal when a transaction does not belong in a specialised journal, or when the entry is an adjustment rather than a straightforward invoice/receipt/payment.

Common uses include:

• credit purchase of a non-current asset (e.g., equipment bought on credit)
• accruals, prepayments, and deferred income adjustments
• depreciation, impairment, inventory write-downs
• allowance for doubtful debts
• loan interest accruals
• equity transactions (share issues, dividends declared)
• correcting entries and reclassifications (where ledger transfers are used)

Core theory and frameworks

Double entry and the accounting equation

Every transaction affects at least two accounts and keeps the accounting equation in balance:

Assets = Liabilities + Equity

Income and expenses ultimately affect equity through retained earnings:

• Income increases equity
• Expenses decrease equity

Double entry ensures the equation stays balanced by recording equal debits and credits.

Debits and credits: a practical rule set

In ledger accounts:

• Assets: debits increase, credits decrease
• Liabilities: credits increase, debits decrease
• Equity: credits increase, debits decrease
• Income: credits increase, debits decrease
• Expenses: debits increase, credits decrease

When you prepare an entry:

1. Identify which accounts change.
2. Decide whether each account increases or decreases, then apply the rules above.

Cash vs credit transactions

• A cash transaction involves immediate payment (bank/cash moves now). Record it in the cash book.
• A credit transaction involves payment later (a receivable or payable is created). Record it in the sales/purchases/returns journals (or the general journal for adjustments or non-trade items).

A quick check is: Did money move today?

• If yes, it belongs in the cash book.
• If no, it belongs in a credit journal or the general journal.

If part is paid now and part later, split the entry: record the cash element in the cash book and record the remaining balance as a receivable or payable.

Goods for resale, operating expenses, and non-current assets

Correct classification affects both profit and financial position:

• Inventory (goods for resale): recorded as an asset when purchased. It becomes an expense (cost of sales) when the goods are sold or written down.
• Operating expenses (e.g., utilities, rent, stationery): recorded as expenses when incurred (subject to accruals and prepayments).
• Non-current assets (e.g., equipment): recorded as assets and expensed over time through depreciation.

A purchase of stationery is an expense, not inventory. A purchase of resale goods is inventory, not an operating expense.

Returns and credit notes

A credit note issued to a customer reduces the customer’s balance and records a return (sales returns).

A credit note received from a supplier reduces the amount payable and records a purchases return (or reduces inventory in a perpetual system).

Settlement discounts

Settlement discounts encourage early payment.

• Discount allowed (given to a customer) is often recorded in a separate discount account.
• Discount received (taken from a supplier) is often recorded in a separate discount account, or treated as a reduction in purchase cost, depending on the bookkeeping approach.

Double entry form:

Customer pays with discount (discount allowed):

• Debit Bank (cash received)
• Debit Discount allowed
• Credit Trade receivables (full amount cleared)

Supplier is paid with discount (discount received):

• Debit Trade payables (full amount cleared)
• Credit Bank (cash paid)
• Credit Discount received (or credit Purchases/Inventory as a reduction in cost, depending on the system used)

Exam note: In basic bookkeeping questions it is common to use discount allowed/received accounts. In more advanced reporting, discounts may be presented as adjustments to revenue or to cost, depending on policy and circumstances. Follow the method implied by the question and apply it consistently.

Correcting entries and reclassifications

Correcting entries fix errors already recorded. They may affect profit if the error involved revenue or expenses.

Reclassifications change presentation categories (for example, separating the portion of a liability due within 12 months from the portion due later). Reclassifications do not change total liabilities or profit; they affect only how balances are shown. Often this is done at the reporting date as part of financial statement preparation and may not require day-to-day ledger postings unless the system uses specific ledger accounts for the split.

Posting flow from journals to the ledger

A typical posting process is:

1. Record transactions in the appropriate journal using source documents.
2. Post individual items to personal accounts (customers and suppliers) where required.
3. Post totals (or analysed totals) to the relevant general ledger accounts.
4. Use ledger balances to prepare a trial balance and then financial statements.

Worked example

Narrative scenario

ABC Ltd is a retail company. During January 2026 it records the following transactions:

1. Credit sale of goods, USD 5,000, to XYZ Corp.
2. Cash sale of goods, USD 2,000
3. Credit purchase of inventory, USD 3,000, from Supplier A.
4. Cash purchase of office supplies, USD 500
5. Goods returned by XYZ Corp, USD 200 (credit note issued).
6. Payment to Supplier A: ABC Ltd settles USD 2,800 of the amount due and takes a 5% settlement discount on that amount.
7. Receipt from XYZ Corp: the customer settles the amount outstanding after the return and takes a 4% settlement discount.
8. Error correction: the office supplies payment was incorrectly entered as USD 600 instead of USD 500
9. Reclassification at the reporting date: a USD 1,000 liability currently shown as current should be shown as non-current.
10. Payment of utilities, USD 300
11. Receipt of USD 1,000 from a non-trade debtor.
12. Error correction: the cash sale was mistakenly posted as USD 2,050 instead of USD 2,000.

Required

• Record each transaction in the appropriate journal.
• Calculate and record settlement discounts.
• Prepare correcting entries for the errors and the reclassification.
• Post the transactions to the ledger and determine the key balances.
• Explain the impact on the financial statements.

Solution

1) Entries in the appropriate journals (double entry shown)

1. Credit sale (Sales Journal)

• Dr Trade receivables – XYZ Corp 5,000
• Cr Sales revenue 5,000

2. Cash sale (Cash book: receipts)

• Dr Bank 2,000
• Cr Sales revenue 2,000

3. Credit purchase of inventory (Purchases Journal)

• Dr Inventory 3,000
• Cr Trade payables – Supplier A 3,000

4. Cash purchase of office supplies (Cash book: payments)

• Dr Office supplies expense 500
• Cr Bank 500

5. Sales return / credit note issued (Sales Returns Journal)

• Dr Sales returns 200
• Cr Trade receivables – XYZ Corp 200

6. Payment to Supplier A with settlement discount (Cash book: payments)

Discount = 5% × 2,800 = 140 Cash paid = 2,800 − 140 = 2,660

• Dr Trade payables – Supplier A 2,800
• Cr Bank 2,660
• Cr Discount received 140

7. Receipt from XYZ Corp with settlement discount (Cash book: receipts)

Amount outstanding after return = 5,000 − 200 = 4,800 Discount = 4% × 4,800 = 192 Cash received = 4,800 − 192 = 4,608

• Dr Bank 4,608
• Dr Discount allowed 192
• Cr Trade receivables – XYZ Corp 4,800

10. Utilities paid (Cash book: payments)

• Dr Utilities expense 300
• Cr Bank 300

11. Receipt from a non-trade debtor (Cash book: receipts)

• Dr Bank 1,000
• Cr Other receivables 1,000

2) Correcting entries and reclassification

8. Correct office supplies error (recorded as 600 instead of 500) The expense is overstated by 100 and bank is understated by 100. Correct by reversing the overstatement:

• Dr Bank 100
• Cr Office supplies expense 100

9. Reclassification at reporting date (presentation adjustment) This does not usually require a journal in day-to-day books unless the system uses specific ledger accounts for the split. The financial statements should present USD 1,000 as non-current rather than current.

Where a ledger transfer is required (between named accounts), one acceptable form is:

• Dr Liability X – current portion 1,000
• Cr Liability X – non-current portion 1,000

(Any equivalent transfer between specific liability accounts is acceptable, provided it reflects the item being re-presented.)

12. Correct misposting of cash sale (posted as 2,050 instead of 2,000) Sales and bank are overstated by 50. Reduce both:

• Dr Sales revenue 50
• Cr Bank 50

3) Key ledger balances after posting (summary)

The postings below summarise the key closing balances rather than showing full ledger T-accounts.

Trade receivables – XYZ Corp

• Debit: 5,000 (credit sale)
• Credit: 200 (return)
• Credit: 4,800 (settlement)
• Closing balance: 0

Trade payables – Supplier A

• Credit: 3,000 (credit purchase)
• Debit: 2,800 (part settlement)
• Closing balance: 200 payable

Bank (net movement)

• Inflows: 2,000 + 4,608 + 1,000 = 7,608
• Outflows: 500 + 2,660 + 300 = 3,460
• Corrections: +100 − 50 = +50
• Net increase in bank: 7,608 − 3,460 + 50 = 4,198

Sales revenue (net)

• Credit: 5,000 + 2,000 = 7,000
• Debit: 50 (correction reducing sales)
• Closing credit balance: 6,950

Sales returns Debit: 200

Discount allowed Debit: 192

Discount received Credit: 140

Office supplies expense (net)

• Debit: 500
• Credit: 100 (correction)
• Closing debit balance: 400

Utilities expense Debit: 300

Inventory Debit: 3,000 (purchase of goods for resale) (No cost of sales entry is shown because the cost information needed to record the expense on sale is not provided in the scenario.)

4) Impact on the financial statements

Statement of financial position (extract effects):

• Bank increases by USD 4,198 (net).
• Inventory increases by USD 3,000.
• Trade receivables close at USD 0 (customer fully settled after return and discount).
• Trade payables include USD 200 still owed to Supplier A.
• A USD 1,000 liability is presented as non-current rather than current (reclassification only).
• Other receivables reduce by USD 1,000 (settled in cash).

Profit impact (excluding cost of sales):

• Sales returns reduce net sales.
• The cash sale correction reduces sales revenue by USD 50.
• Discount allowed and discount received affect profit according to the approach used in the question and the accounting policy applied.
• Operating expenses include office supplies (after correction) and utilities.

Common pitfalls and misunderstandings

• Recording cash sales in the Sales Journal: cash sales belong in the cash book because bank/cash moves immediately.
• Treating the Purchases Journal as “inventory only” in all systems: many bookkeeping systems (and many exam questions) treat it as the journal for credit invoices, often including analysed credit expenses.
• Recording returns directly in Sales: use sales returns and purchases returns so that gross figures and contra amounts remain visible.
• Confusing settlement discounts: discount allowed relates to customers; discount received relates to suppliers.
• Correcting an overstatement in the wrong direction: if an expense is overstated, credit the expense to reduce it (and debit the account that was understated).
• Assuming corrections never affect profit: a correction can affect profit if it involves revenue or expenses.
• Posting reclassifications to generic headings: transfers (if used) should be between specific named liability accounts; otherwise the change is made at the presentation stage.

Summary

Journals and day books organise routine transactions before posting to the ledger. Credit transactions are recorded in the sales/purchases/returns journals, while cash movements are recorded in the cash book, which commonly also serves as the bank/cash ledger account in many bookkeeping systems. Adjustments and non-routine entries are recorded in the general journal. Correct classification (cash vs credit, trade vs non-trade, inventory vs expense vs non-current asset) produces reliable ledger balances and supports accurate financial statements. Settlement discounts and error corrections require careful double entry to ensure receivables and payables are cleared correctly.

FAQ

Why use journals instead of writing everything straight into the ledger? Journals group similar transactions and create a clear trail from source documents to ledger postings, improving efficiency and reducing posting errors.

Does the Purchases Journal record only goods for resale? Not always. Many bookkeeping systems (and many exam questions) use it for credit invoices generally, often including analysed credit expenses. Non-current assets bought on credit are commonly recorded separately through the general journal or an asset register.

What is the cash book in bookkeeping questions? It is the record of cash and bank receipts and payments and, in many systems, it also functions as the ledger account for bank/cash (especially where a columnar cash book is used).

What if part is paid now and part later? Split the entry: record the cash element in the cash book and record the remaining balance as a receivable or payable.

Is a reclassification always recorded with a journal entry? Often it is a reporting-date presentation adjustment. If a transfer is recorded in the ledger, it should be between specific accounts (for example, splitting a liability into current and non-current portions).

Glossary

Book of first entry A record where transactions are first written up from source documents before being posted into ledger accounts.

Journals (day books) Books of first entry that list routine transactions by type (such as sales, purchases, returns, receipts and payments) to support efficient posting and a clear audit trail.

Sales Journal (Sales Day Book) A journal used to record credit sales of goods, posted to trade receivables and sales revenue.

Purchases Journal (Purchases Day Book) A journal used to record credit invoices, commonly including purchases of goods and often analysed credit expenses. Non-current assets on credit may be excluded depending on the system.

Cash book The record of cash and bank receipts and payments. In many bookkeeping systems it also serves as the ledger account for bank/cash and may include contra transfers.

Sales Returns Journal A journal used to record returns by customers and credit notes issued, posted to sales returns and trade receivables.

Purchases Returns Journal A journal used to record returns to suppliers and supplier credit notes, posted to trade payables and either purchases returns (periodic systems) or inventory (perpetual systems).

General Journal A journal used for adjustments and non-routine entries such as accruals, prepayments, depreciation, allowances, corrections, and (where used) ledger transfers for reclassifications.

Settlement discount A reduction in the amount paid or received when an invoice is settled early, recorded in a manner consistent with the question and the bookkeeping system used.

Learning objectives

By the end of this chapter, you will be able to:

• Explain double-entry bookkeeping and the normal balance for assets, liabilities, equity, income, and expenses.
• Post transactions from journals to the general ledger and explain how some errors can leave the trial balance in agreement while individual accounts are wrong.
• Calculate and interpret closing balances using opening balance + movements (with movements analysed into debits and credits).
• Prepare and interpret trade receivables and trade payables control accounts.
• Apply period-end adjustments (accruals, prepayments, depreciation, and allowances for receivables) and explain their effects on ledger balances and financial statements.

Overview & key concepts

The general ledger is the central record of an entity’s financial activity. Each ledger account collects postings for a particular category (for example, cash, sales, inventory, trade receivables, trade payables, wages, and so on). Ledger balances are extracted into a trial balance and used to prepare the financial statements.

To post confidently, you need three building blocks:

• The accounting equation: assets are financed by liabilities and equity.
• Double-entry: every transaction records equal debits and credits.
• Timing adjustments: some entries are needed to ensure income and expenses are recognised in the correct period and assets/liabilities are stated appropriately.

Core theory and frameworks

1) The accounting equation and what equity represents

At the broadest level:

Assets = Liabilities + Equity

Equity is what belongs to the owners once you take account of everything the business owes to outsiders. Another way to think about it is: assets are the resources controlled by the business, liabilities are outside claims on those resources, and equity is the remaining claim.

Over time, equity changes mainly because:

• the business makes profits or losses (income increases equity; expenses reduce it), and
• the owners inject funds or take value out (for example, through dividends).

2) Debits, credits, and normal balances

A ledger account has two sides:

• Debit (Dr)
• Credit (Cr)

“Normal balance” means the side that typically carries the positive closing balance for that type of account:

• Assets: normally debit
• Expenses: normally debit
• Liabilities: normally credit
• Income: normally credit
• Equity: normally credit

A practical rule:

• If an account’s normal balance is debit, then debits increase it and credits decrease it.
• If an account’s normal balance is credit, then credits increase it and debits decrease it.

Example (cash purchase of office supplies):

• Office supplies (asset) increases → Dr office supplies
• Cash (asset) decreases → Cr cash

3) Cash vs credit transactions

A common posting error is confusing how a transaction is paid with when income or expenses are recognised.

• Cash sale: Dr cash / Cr sales (plus any tax element if applicable).
• Credit sale: Dr trade receivables / Cr sales (plus any tax element).
• Cash purchase (expense): Dr expense / Cr cash.
• Credit purchase (expense or inventory): Dr expense or inventory / Cr trade payables.

Settlement is a separate step:

• Collect from customer: Dr cash / Cr trade receivables.
• Pay supplier: Dr trade payables / Cr cash.

4) Operating expenses, accruals, and prepayments

Operating expenses are recognised in the period they relate to, not simply when cash is paid.

Accrual: an expense has been incurred but not paid at the period end.

• Entry: Dr expense / Cr accrual (liability)

Prepayment: cash has been paid in advance for a future period.

• Entry on payment: Dr prepayment (asset) / Cr cash
• As time passes: Dr expense / Cr prepayment

5) Inventory and cost of sales in ledger terms

Inventory accounting depends on the system used:

• Perpetual system: inventory and cost of sales update as purchases and sales occur.
• Periodic system: purchases may be recorded during the year and cost of sales is determined at the end using opening inventory, purchases, and closing inventory.

At a high level, ledger postings must achieve two outcomes:

• Inventory (asset) reflects goods still held.
• Cost of sales (expense) reflects goods sold in the period.

6) Deferred income (unearned revenue)

Deferred income arises when cash is received before goods or services are provided.

• On receipt: Dr cash / Cr deferred income (liability)
• When earned: Dr deferred income / Cr income

7) Notes payable (loans) and interest

Typical entries:

• When funds are received: Dr cash / Cr loan payable
• When interest accrues (even if unpaid): Dr interest expense / Cr interest payable
• When interest is paid: Dr interest payable (if accrued) / Cr cash

8) Allowance for receivables and write-offs

Keep these separate:

Specific write-off: remove a confirmed irrecoverable customer balance.

• Entry (common approach): Dr irrecoverable debt expense / Cr trade receivables
• If an allowance already exists and the question indicates it is used: Dr allowance for receivables / Cr trade receivables

Allowance estimate: a year-end adjustment for remaining receivables.

• Entry: Dr irrecoverable debt expense / Cr allowance for receivables
• In most questions, you post only the movement needed from the opening allowance to the required closing allowance.

Exam technique: if opening allowance is a credit and required closing allowance is a credit, compare the two and post the difference.

9) Equity transactions: share capital, share premium, dividends, retained earnings

Issue of shares:

• Share capital is credited with the nominal value.
• Any excess received is credited to share premium.

Dividends: dividends are distributions to owners and are not an expense.

• A dividend liability is recognised only when the dividend is properly authorised/declared and is no longer at the entity’s discretion.

Some entities post dividends to a separate dividends (equity) account and transfer it to retained earnings later. Others post dividends directly to retained earnings. Both approaches reduce equity, not profit.

10) VAT control account mechanics

Where VAT applies:

• Output VAT: tax charged on sales.
• Input VAT: tax charged by suppliers on purchases (often recoverable, subject to local rules).

Net VAT:

• Payable if output VAT exceeds input VAT.
• Receivable if input VAT exceeds output VAT.

A credit balance on VAT control usually represents VAT payable; a debit balance usually represents VAT receivable (depending on how the ledger is set up).

Currency is illustrative throughout this chapter.

11) Suspense accounts

A suspense account is a temporary holding account used when the correct posting is not yet known. It keeps the bookkeeping system balanced while information is investigated. Suspense balances should be cleared promptly.

Worked example

Narrative scenario

ABC Corporation operates in a VAT environment. During the year, the following transactions occurred:

1. Credit sales of $200,000 were made. Output VAT of $12,000 relates to these sales.
2. Cash of $150,000 was received from customers. Included in this was a $5,000 receipt that was initially credited to a suspense account because the customer could not be identified at the time.
3. Raw materials were purchased on credit for $80,000. Input VAT of $8,000 relates to these purchases.
4. Cash of $60,000 was paid to suppliers.
5. Utility expenses of $5,000 were incurred during the year and were paid in the following month (after year end).
6. Depreciation of $10,000 was recorded on machinery.
7. Shares with a nominal value of $1 each were issued for $1.50 per share, raising $45,000 in total.
8. Dividends of $5,000 were paid to shareholders.
9. Bad debts of $2,000 were written off.
10. An accrual of $3,000 was recorded for unpaid salaries at the year end.
11. An insurance prepayment of $4,000 was made during the year and relates entirely to the next accounting period.
12. Interest income of $1,000 was earned during the year and will be received after year end.

Assume opening balances for trade receivables and trade payables are $0, and there is no opening allowance for receivables.

Required

1. Prepare the trade receivables control account and calculate the closing balance.
2. Prepare the trade payables control account and calculate the closing balance.
3. Prepare the VAT control account and calculate the net amount payable or receivable.
4. Record journal entries for: utilities (accrual), salaries (accrual), insurance (prepayment), and interest income (accrued income).
5. Record the journal entry for depreciation of machinery.
6. Prepare the journal entry for the issue of shares.
7. Record the dividend payment and state when a dividend liability would be recognised.
8. Clear the suspense account once the customer is identified.
9. Adjust the allowance for receivables to 5% of closing trade receivables and show the year-end adjustment.

Solution

1) Trade receivables control account (asset: debit balance)

• Credit sales (gross): $200,000 + $12,000 = $212,000
• Cash received: $150,000 total, of which $5,000 was credited to suspense initially → allocated to receivables initially $145,000
• Bad debts written off:$2,000
• Suspense cleared to receivables:$5,000

Trade receivables control

Closing balance:$60,000 debit (amount owed by customers)

2) Trade payables control account (liability: credit balance)

• Credit purchases (gross): $80,000 + $8,000 = $88,000
• Cash paid:$60,000

Trade payables normally carry a credit closing balance. To “total off” the account, Balance c/d is placed on the debit side (the opposite side) so that both sides agree.

Trade payables control

Closing balance:$28,000 credit (amount owed to suppliers)

3) VAT control account and net VAT

• Output VAT = $12,000
• Input VAT = $8,000

Net VAT = $12,000 − $8,000 = $4,000 payable

A credit balance on VAT control usually represents VAT payable; a debit balance usually represents VAT receivable (depending on how the ledger is set up).

4) Utilities accrual, salaries accrual, insurance prepayment, and interest receivable

(a) Utilities accrued (incurred, unpaid at year end)

• Dr Utilities expense $5,000
• Cr Utilities accrual (payable) $5,000

(b) Salaries accrued (unpaid at year end)

• Dr Salaries expense $3,000
• Cr Salaries accrual (payable) $3,000

(c) Insurance paid in advance (relates entirely to next period)

• Dr Prepaid insurance $4,000
• Cr Cash $4,000

(d) Interest income earned but not yet received

• Dr Interest receivable $1,000
• Cr Interest income $1,000

5) Depreciation journal entry

• Dr Depreciation expense $10,000
• Cr Accumulated depreciation (machinery) $10,000

6) Share issue journal entry

Proceeds: $45,000 at $1.50 per share → shares issued = $45,000 / $1.50 = 30,000 shares

• Share capital = 30,000 × $1 = $30,000
• Share premium = $45,000 − $30,000 = $15,000

Journal:

• Dr Cash $45,000
• Cr Share capital $30,000
• Cr Share premium $15,000

7) Dividend payment and when a dividend liability arises

Dividends are distributions to owners and do not reduce profit.

Dividend paid during the year (paid immediately):

• Dr Dividends (equity) $5,000
• Cr Cash $5,000

Some entities post dividends directly to retained earnings (Dr retained earnings / Cr cash). Both approaches reduce equity, not profit.

A dividend liability is recognised only when the dividend is properly authorised/declared and is no longer at the entity’s discretion. If declared but unpaid:

• Dr Dividends (equity)
• Cr Dividend payable (liability)

8) Suspense account clearance

Initial unidentified receipt:

• Dr Cash $5,000
• Cr Suspense $5,000

When the customer is identified:

• Dr Suspense $5,000
• Cr Trade receivables $5,000

9) Allowance for receivables at 5%

Closing trade receivables = $60,000 Required allowance = 5% × $60,000 = $3,000

Assuming no opening allowance, the year-end adjustment is:

• Dr Irrecoverable debt expense $3,000
• Cr Allowance for receivables $3,000

Movement logic: if an opening allowance exists (credit) and the required closing allowance is also a credit, compare them and post only the difference.

Bad debt write-off note: the $2,000 write-off removes the specific customer balance:

• Dr Irrecoverable debt expense $2,000
• Cr Trade receivables $2,000

(If an allowance balance was given and the question indicated it should be used, the debit would usually be to the allowance instead.)

Interpretation of the results

• Trade receivables closing balance ($60,000): the gross amount customers still owe, affecting liquidity and working capital.
• Trade payables closing balance ($28,000): the gross amount owed to suppliers, affecting working capital and near-term cash planning.
• Net VAT payable ($4,000): a short-term liability to the tax authority.
• Accruals (utilities and salaries): increase expenses (lower profit) and create liabilities (higher payables).
• Prepayment (insurance): creates an asset; it does not affect current-year profit on these facts.
• Interest receivable: increases income (higher profit) and creates an asset.
• Depreciation: reduces profit and reduces the asset’s carrying amount via accumulated depreciation.
• Share issue: increases cash and increases equity (share capital and share premium).
• Dividend paid: reduces cash and reduces equity; it does not affect profit.
• Suspense cleared: removes an artificial balance and ensures receivables are correctly stated.

Common pitfalls and misunderstandings

• Incorrect “balance c/d” placement when totalling off: balance c/d is placed on the opposite side to the closing balance so totals agree.
• Ignoring VAT in receivables/payables control accounts: customers and suppliers usually settle gross amounts—control accounts should reflect that when VAT is stated separately.
• Confusing timing with payment: expenses can exist without payment (accruals), and payments can exist without expense (prepayments).
• Mixing up allowance and write-off: write-offs remove specific debts; the allowance is a year-end estimate on remaining receivables.
• Posting dividends as an expense: dividends reduce equity, not profit.
• Leaving suspense balances unresolved: suspense is temporary and should be cleared once details are known.

Summary and further reading

The general ledger organises transactions into accounts so that balances can be extracted and financial statements prepared. Double-entry ensures each transaction records equal debits and credits, keeping the ledger in balance.

Control accounts summarise receivables and payables and support reconciliation to detailed listings. Period-end adjustments—accruals, prepayments, depreciation, accrued income, and allowances for receivables—ensure profit is measured for the correct period and assets and liabilities are stated appropriately.

FAQ

What is the purpose of a control account?

A control account summarises the total activity and balance from individual customer or supplier accounts. It provides a check on completeness and accuracy: the control account should agree to the total of the detailed listing after reconciliation for timing differences and identified errors.

How do accruals and prepayments affect financial statements?

Accruals record costs (or income) relating to the period even if unpaid (or unreceived) at the reporting date, creating liabilities (or assets). Prepayments record payments made in advance as assets, which are released to expense as time passes. Both adjustments help ensure profit reflects the correct period.

What errors can leave the trial balance in agreement but still be wrong?

If equal debits and credits are recorded but posted to the wrong accounts, the trial balance can still balance while individual balances are misstated. Examples include posting a receipt to the wrong customer, recording the wrong amount on both sides, or using the wrong expense category.

How is depreciation recorded in the general ledger?

Depreciation is recorded by debiting depreciation expense and crediting accumulated depreciation. The expense reduces profit, while accumulated depreciation reduces the asset’s carrying amount.

What is the role of a suspense account?

A suspense account is a temporary holding account used when the correct posting is not yet known. Once resolved, the balance is transferred to the correct account so suspense returns to nil.

How do you adjust an allowance for receivables?

Determine the allowance required at the reporting date, compare it to the opening allowance, and post only the movement. If both opening and required allowances are credit balances, the adjustment is the difference between the two.

Summary (Recap)

This chapter explained how the general ledger records transactions using double-entry and how normal balances guide debit and credit postings. It showed how to calculate closing balances from opening balances and movements, and how control accounts summarise receivables and payables activity. It also covered key period-end adjustments (accruals, prepayments, depreciation, accrued income, and allowances for receivables), and the correct treatment of VAT, suspense items, share issues, and dividends. The worked example demonstrated consistent “total off” conventions for control accounts and linked postings to closing balances.

Glossary

General ledger The main set of accounts that accumulates transactions by category (assets, liabilities, equity, income, and expenses) and provides balances used to prepare financial statements.

Double-entry bookkeeping A recording method where every transaction is entered with equal debits and credits across at least two accounts, so the ledger remains in balance.

Normal balance The side (debit or credit) on which an account type typically carries its closing balance.

Control account A summary ledger account (for example, trade receivables or trade payables) that should agree to the total of individual balances in a detailed listing after reconciliation.

Accrual A period-end posting that records an expense or income for the period and creates the matching payable or receivable when cash has not yet been paid or received.

Prepayment A payment made before the related expense is due; it is recorded as an asset and later transferred to expense as the benefit is used up.

Deferred income Money received before income is earned, recorded as a liability and later transferred to income when the goods or services are provided.

Depreciation An accounting entry that spreads an asset’s cost across the periods it is used. In the ledger it is an expense with a matching credit to accumulated depreciation, reducing the asset’s carrying amount over time without any cash payment.

Suspense account A temporary holding account used when the correct posting is not yet known, cleared once the correct information is obtained.

Allowance for receivables An estimate recorded to reduce trade receivables to the amount expected to be collected, with the adjustment recognised in irrecoverable debt expense.

VAT control account A ledger account that gathers output VAT and input VAT and shows the net amount payable to or recoverable from the tax authority.

Share capital / share premium Share capital records the nominal value issued to owners; share premium records amounts received above nominal value.

Dividend A distribution to owners that reduces equity and does not form part of expenses.

Learning objectives

• Explain why journals and ledgers are used, and how they support accurate double-entry records.
• Prepare journal entries from transaction narratives, applying correct debit and credit rules.
• Post journal entries to ledger (T-) accounts and maintain clear account movements.
• Balance ledger accounts at period end, using balance c/d and balance b/d correctly.
• Record common period-end adjustments (accruals, prepayments, depreciation) so income and expenses fall in the correct period.
• Identify and correct common recording and posting errors without breaking double entry.

Overview & key concepts

Financial accounting relies on a disciplined record of transactions so that income, expenses, assets, liabilities, and equity can be reported consistently. Two core tools make this possible:

• Journals: transactions are first recorded in date order using double entry (total debits = total credits).
• Ledgers: entries are grouped by account so movements and balances can be reviewed and financial statements prepared.

A good system links each transaction to: (1) the business event, (2) the accounts affected, and (3) the impact on the accounting equation.

Assets = Liabilities + Equity

Journals

A journal is the first formal record of a transaction. A typical journal entry shows:

• date
• accounts debited and credited
• amounts
• a short narrative explaining the entry

Example (equipment bought and paid immediately from the bank):

• Debit Equipment (asset increases)
• Credit Bank (asset decreases)

Journals provide a clear audit trail: what was recorded, when, and why.

Ledgers

A ledger is a set of accounts used to accumulate transactions by type (e.g., Bank, Trade receivables, Sales revenue, Rent expense). The general ledger contains all accounts required to prepare financial statements.

Ledger accounts allow you to:

• track amounts owed by customers and owed to suppliers
• monitor cash and bank movements
• summarise income and expenses for the period

Posting

Posting transfers each line of a journal entry into the relevant ledger accounts:

• a debit in the journal becomes a debit in the ledger account
• a credit in the journal becomes a credit in the ledger account

For exam technique, label each ledger entry with the counterparty account (the other account in the journal entry). This makes it easier to cross-check postings.

Balancing accounts

At the end of a period, ledger accounts are balanced to determine the closing position.

Exam layout rule (balance-off method)

• Add up each side.
• Put balance c/d on the shorter side so that debit total = credit total.
• Bring down balance b/d on the opposite side at the start of the next period.
• Balance c/d is the balancing figure needed to make the two totals equal.

Reminder: the side where balance c/d appears depends on which side is shorter.

Year-end adjustments

Period-end adjustments ensure that income and expenses are reported in the correct accounting period and that assets and liabilities are not misstated. Common adjustments include:

• Accruals (expenses incurred but not yet paid)
• Prepayments (paid in advance for future periods)
• Depreciation (allocation of an asset’s cost over its useful life)
• Irrecoverable debts / allowance for doubtful debts (covered later)
• Deferred income (covered later)

Example (insurance prepayment): if a payment includes an amount relating to the next period, that future portion is recorded as a prepayment (asset), reducing the current period expense.

Importance of narratives

A short narrative supports the entry by stating the business reason for it. This is especially useful for adjustments and corrections.

Core theory and frameworks

Double-entry and the accounting equation

Every transaction affects at least two accounts so that the accounting equation remains in balance:

Assets = Liabilities + Equity

A practical method is:

1. Identify what the business receives and what it gives.
2. Name the accounts involved.
3. Classify each account as asset, liability, equity, income, or expense.
4. Decide whether each account increases or decreases, then apply the normal balance rule to choose debit or credit.

Normal balances (a quick way to remember debits and credits)

Most accounts have a “natural” side where increases usually sit:

• assets and expenses usually build up on the debit side
• liabilities, equity, and income usually build up on the credit side

When an account increases, you normally post it on its natural side; when it decreases, you post it on the opposite side.

Cash vs credit transactions

• A cash/bank sale increases Bank (or Cash) immediately.
• A credit sale creates a receivable first; cash is recorded later when received.
• A credit purchase creates a payable first; payment reduces that payable later.

Operating expenses

Operating expenses (rent, utilities, salaries) are recognised in the period to which they relate:

• unpaid at period end → recognise an accrual (liability)
• paid in advance → recognise a prepayment (asset)

Inventory systems and cost of sales (high level)

Goods purchased for resale are accounted for using either:

• Perpetual system: inventory is updated continuously as purchases and sales occur.
• Periodic system: purchases are accumulated during the period (often in a Purchases account) and cost of sales is determined at period end using opening inventory and closing inventory.

In exam-style questions, you are usually told which system is used, or you are given opening and closing inventory so that cost of sales can be calculated.

Period-end depreciation

Depreciation is recorded with:

• Debit Depreciation expense
• Credit Accumulated depreciation (a contra-asset)

The asset cost remains unchanged. Net book value is:

Net book value = Cost − Accumulated depreciation

Error correction (exam-focused, concise)

Common error patterns and typical fixes:

• Omission: record the correct entry.
• Wrong account: reclassify by debiting the correct account and crediting the incorrect account.
• Wrong side: reverse the incorrect posting and record it on the correct side.
• Transposition/casting error: adjust by the difference once the correct figure is known.

Mini-example (wrong account): rent £500 posted to utilities. Debit Rent expense £500 Credit Utilities expense £500

Worked example

Narrative scenario

Greenfield Supplies operates in the UK. During March, the business completed these transactions:

1. Introduced cash capital of £12,000 into the business bank account.
2. Purchased equipment for £3,600 by bank transfer.
3. Bought goods on credit for £2,200.
4. Sold goods on credit for £3,100.
5. Paid £800 to a supplier by bank transfer.
6. Paid rent of £500 by bank transfer.
7. Received a loan of £5,000 from a bank.
8. Paid salaries of £1,200 in cash.
9. Received £1,500 from a customer for a previous credit sale.
10. Paid £300 for utilities by bank transfer.
11. Recorded depreciation of £400 on equipment.
12. Made a period-end adjustment for £200 of accrued expenses.

Required

• Prepare journal entries for each transaction.
• Post the entries to the relevant ledger accounts.
• Balance the ledger accounts at the end of March.
• Record period-end adjustments for accrued expenses and depreciation.
• Interpret the financial position as at 31 March.

Solution

Journal entries

1) Capital introduced into bank Debit Bank £12,000 Credit Capital £12,000 Narrative: Owner introduced capital into business bank account.

2) Equipment purchased by bank transfer Debit Equipment (cost) £3,600 Credit Bank £3,600 Narrative: Equipment purchased and paid by bank transfer.

3) Goods purchased on credit Debit Inventory £2,200 Credit Trade payables £2,200 Narrative: Goods purchased on credit.

4) Goods sold on credit Debit Trade receivables £3,100 Credit Sales revenue £3,100 Narrative: Credit sale to customer.

5) Part payment to supplier by bank Debit Trade payables £800 Credit Bank £800 Narrative: Part payment made to supplier.

6) Rent paid by bank Debit Rent expense £500 Credit Bank £500 Narrative: Rent paid by bank transfer.

7) Loan received into bank Debit Bank £5,000 Credit Loan payable £5,000 Narrative: Loan proceeds received from bank.

8) Salaries paid in cash (a) Cash withdrawn from bank for wages Debit Cash £1,200 Credit Bank £1,200 Narrative: Cash withdrawn from bank to fund wage payment.

(b) Salaries paid in cash Debit Salaries expense £1,200 Credit Cash £1,200 Narrative: Salaries paid in cash.

9) Receipt from customer (settling a receivable) Debit Bank £1,500 Credit Trade receivables £1,500 Narrative: Receipt from customer to settle outstanding receivable.

10) Utilities paid by bank Debit Utilities expense £300 Credit Bank £300 Narrative: Utilities paid by bank transfer.

11) Depreciation for the period Debit Depreciation expense £400 Credit Accumulated depreciation – equipment £400 Narrative: Depreciation recorded for March.

12) Accrued expense at period end Debit Utilities expense £200 Credit Accruals (accrued liabilities) £200 Narrative: Recognise an expense relating to March that has not yet been paid; set up a liability for the amount owing.

Ledger accounts (T-accounts with balancing shown)

Bank (balanced off correctly)

Balance b/d (1 April): 12,100 (debit)

Cash

Balance b/d (1 April): 0

Equipment (cost)

Balance b/d (1 April): 3,600 (debit)

Accumulated depreciation – equipment

Balance b/d (1 April): 400 (credit)

Inventory

Balance b/d (1 April): 2,200 (debit)

Trade payables

Balance b/d (1 April): 1,400 (credit)

Trade receivables (balanced off correctly)

Balance b/d (1 April): 1,600 (debit)

Sales revenue

Balance b/d (1 April): 3,100 (credit) Note: Income and expense accounts are later closed to profit for the period. Carrying them forward here is only to demonstrate balancing technique before that closing step is introduced.

Rent expense

Balance b/d (1 April): 500 (debit)

Utilities expense

Balance b/d (1 April): 500 (debit)

Salaries expense

Balance b/d (1 April): 1,200 (debit)

Depreciation expense

Balance b/d (1 April): 400 (debit)

Accruals (accrued liabilities)

Balance b/d (1 April): 200 (credit)

Loan payable

Balance b/d (1 April): 5,000 (credit)

Capital

Balance b/d (1 April): 12,000 (credit)

Key balances at 31 March (selected)

• Bank (asset): £12,100
• Trade receivables (asset): £1,600
• Inventory (asset): £2,200
• Equipment at cost (asset): £3,600
• Accumulated depreciation (contra-asset): £400

Net book value = Cost − Accumulated depreciation Net book value = £3,600 − £400 = £3,200

• Trade payables (liability): £1,400
• Accruals (accrued liabilities) (liability): £200
• Loan payable (liability): £5,000
• Capital (equity): £12,000

Interpretation of the financial position (31 March)

Greenfield Supplies ends March with £12,100 in the bank and no cash on hand, after funding a cash wage payment via a bank withdrawal. Working capital includes trade receivables of £1,600 and trade payables of £1,400, reflecting credit trading with a modest net receivable position.

Non-current assets include equipment at cost £3,600 with accumulated depreciation £400, giving a net book value of £3,200. The business also has a loan payable of £5,000, which increases funding but adds repayment and interest commitments in future periods.

No cost of sales is calculated because the scenario does not provide information on inventory issued/sold or closing inventory.

Common pitfalls and misunderstandings

• Confusing debit and credit rules: classify the account type first, then decide increase/decrease.
• Mixing up bank and cash: “paid in cash” affects Cash; if cash came from the bank, record the withdrawal.
• Using a generic “accrued expense” account: debit the specific expense heading and credit Accruals (liability).
• Crediting the asset cost for depreciation: use accumulated depreciation.
• Putting balance c/d on the wrong side: it must go on the shorter side to make totals equal.
• Forgetting nominal account closure: income and expenses are later transferred to profit for the period.

Summary

Journals record transactions in date order using double entry, while ledgers group those entries by account to build running balances. Balancing off ledger accounts identifies closing positions and ensures continuity into the next period. Period-end adjustments such as accruals and depreciation ensure expenses are recognised in the correct period and that assets and liabilities are not misstated.

FAQ

Why does double entry matter?

Double entry forces every transaction to have two equal sides, which helps maintain the accounting equation and supports internal checks through ledger balancing.

How do I choose which account to debit?

Identify the accounts, classify them, decide whether each increases or decreases, then apply the normal balance rule to select debit or credit.

Why record an accrued expense at period end?

Because the expense relates to the current period even if paid later. The adjustment recognises the expense now and sets up a liability for the amount owing.

Why keep accumulated depreciation separate?

Separating cost and accumulated depreciation makes it easier to track original cost, total depreciation to date, and net book value.

Glossary

Journal A day-by-day record where transactions are first entered using double entry, showing debits, credits, amounts, and a brief narrative.

Ledger A collection of accounts where transactions are accumulated by account type to produce account balances.

Posting Transferring each debit and credit from the journal to the relevant ledger accounts.

Debit An entry on the left side of an account. It is commonly used for increases in assets and expenses, and for decreases in liabilities, equity, and income.

Credit An entry on the right side of an account. It is commonly used for increases in liabilities, equity, and income, and for decreases in assets and expenses.

Balance c/d (carried down) A closing figure inserted on the shorter side of a T-account so that debit total equals credit total.

Balance b/d (brought down) The opening balance in the next period, brought down on the opposite side from the balance c/d.

Accrual A period-end adjustment that records an expense (or income) in the period it relates to when the cash movement happens later.

Accruals (accrued liabilities) Amounts owed at the period end for expenses already recognised.

Prepayment A payment made in advance where the benefit relates to a future period; the unexpired amount is recorded as an asset.

Depreciation A periodic charge that spreads the cost of a tangible non-current asset over its useful life.

Accumulated depreciation A contra-asset account that accumulates depreciation over time and is offset against the asset’s cost to determine net book value.

General ledger The main set of accounts containing assets, liabilities, equity, income, and expenses used to prepare financial statements.

Nominal account An income or expense account used to measure performance for a period, later transferred to profit for that period.