Ledger accounts: Simple breakdown of Types, Format, Double Entry, Balance

Ledgers is the third step in the Accounting Cycle. After you sort out Source Documents and record the amounts into the 7 Journals, the figures then go to the ledger accounts. Each account records details of every activity that happens in a business.

From the day the owner invests money into the business, ledger accounts are opened to record activities. If he does not have enough money, he borrows from the bank, a friend or a lending institution to fund his spending.

He uses some of the money to buy a machine, vehicle, goods for resale, and spend some of it on rent, electricity, and salaries to get work done to generate income. The money he earns is used to pay back part of his loans and to buy more goods for resale.

Some customers pay with cash, others buy goods on credit. They return goods to the business or receive a discount. The same goes for suppliers. Also, bills are sometimes paid late or paid in advance. All these activities must be recorded in order to know if the business is making a profit or a loss. There are 3 types of ledgers that record all transactions.

3 Types of ledgers

1. General Ledger

The General Ledger records all transactions. After all the entries are recorded in the respective Journals, each one gets its own name in the General Ledger. The accounts are numbered so that they correspond with the entries made in the Journals using a Folio column.

Some accounts only record totals. Sales account records total cash sales from the Cash Book and total credit sales from the Sales Journal. Purchases account records total cash purchases from the Cash Book and total credit purchases from the Purchases Journal. Returns inwards and Returns outwards accounts record totals from the Returns inwards and Returns outwards Journals.

2. Sales Ledger

The Sales Ledger records all Accounts Receivable accounts and their details. Debtors get separate accounts named after them. All credit sales, returns inwards, and discounts allowed are recorded in the individual accounts.

If the business sells goods to P Mart on credit, the first record of this appears in the Sales Journal. Then, an account called Accounts receivable: P Mart account is opened in the Sales Ledger to show the debt.

If P Mart returns some of the goods, pays off the remaining debt, and is given a discount, then these activities are recorded in the same account to show that the debt is closed off. If the debt is not paid by the end of the financial period however then the balance goes to the next period as an account receivable.

3. Purchases Ledger

The Purchases Ledger records all Accounts Payable accounts and their details. Creditors get separate accounts named after them. All credit purchases, returns outwards, and discounts received are recorded in the individual accounts.

If the business buys goods from D Supplies on credit, the first record of this appears in the Purchases Journal. Then, an account called Accounts payable: D Supplies account is opened in the Purchases Ledger to show the debt.

If the business returns some of the goods to D Supplies, pays off the remaining debt, and receives a discount, then these activities are recorded in the same account to show that the debt is closed off. If the debt is not paid by the end of the financial period however then the balance goes to the next period as an account payable.

Format of Ledger accounts

The ledger is shaped like a capital T. There is a horizontal line across and a vertical line that starts at top centre of this line that goes straight down.

Name at top of the ledger account

The name at the top of the ledger account is either an asset, liability, income, capital or expense. Examples are:

• Asset – Building, Debtors, Prepaid expense, Bank, Cash
• Liability – Loan, Creditors, Accrued expense, Prepaid revenue, Bank overdraft
• Income – Sales, Proceeds, Returns outwards, Discount received, Rent revenue, Bad debts recovered
• Capital – Cash at start, Owner’s savings, Money out of pocket, Shareholders’ money, Partners’ contributions
• Expenses – Purchases, Carriage inwards, Carriage outwards, Discount allowed, Returns inwards, Rent, Salaries, Utilities, Insurance, Bad debts, Depreciation

Left and right sides of the ledger account

The left side at the top of the ledger account is labelled Dr which is debit and the right side is labelled Cr which is credit. Each side is divided into 4 columns labelled Date, Details, Folio, $.

Date column

The date column records the year, month and day of a transaction. It is the first column on both the left and right sides.

Details column

The details column records the name of the other party involved in a transaction. It is the second column on both the left and right sides.

Folio column

The Folio column records the book of original entry for the transaction. The name of the book is written a particular way:

• GJ 1 is General Journal Page 1
• CB 3 is Cash Book Page 3
• SJ 1 is Sales Journal Page 1
• PJ 2 is Purchases Journal Page 2
• RIJ 3 is Returns Inwards Journal Page 3
• ROJ 1 is Returns Outwards Journal Page 1

Dollar column

The dollar column records the value of the item. It is written as a $ sign.

A horizontal line is drawn under all the labels. This format accommodates the entries of business transactions using the double entry system.                                                            

Double Entry System

Every transaction has two entries, a debit and a credit. This occurs when one account increases while one decreases or both accounts increase or decrease at the same time.

If a business buys a motor vehicle with cash, it means the Motor Vehicle account increases with a debit and the Cash account decreases with a credit.

If the motor vehicle is bought on credit, then two accounts increase. The Motor Vehicle account increases with a debit and the Accounts Payable account increases with a credit.

If the business pays off the debt with cash, then two accounts decrease. The Accounts Payable account decreases with a debit and the Cash account decreases with a credit.

Learn ALICE accounts

In order to know which accounts are debited and credited when they increase or decrease, you must know your ALICE accounts. These accounts are assets, liabilities, income, capital, and expenses. In the double entry system:

DEBIT

• Increase of assets and expenses
• Decrease of liabilities, income, and capital

CREDIT

• Decrease of assets and expenses
• Increase of liabilities, income, and capital

5 Important things to know when recording transactions

While every transaction has a debit and a credit, some accounts are a bit tricky. Here are 5 important things to know about the double entry system.

1. A transaction can have simple debit and credit entries

An owner investing money into a business is a simple transaction. Both the Capital account and Cash account increase at the same time. The double entry for this transaction is debit the Cash account and credit the Capital account.

Using the format, you must draw up two accounts. The names at the top are Cash and Capital. The Cash account records Capital in Details column on the debit side. The Capital account records Cash in the Details column on the credit side.

2. Purchases account only records goods for resale

When the business buys goods for resale using cash, this account is called Purchases and it is an expense. The Purchases account increases and the Cash account decreases. The double entry for this is debit the Purchases account and credit the Cash account.

However, when the business buys a motor vehicle using cash, this transaction is handled differently from when goods are bought for resale.

Since the motor vehicle stays in the business for more than one year, it is a fixed asset and cannot be recorded in the Purchases account. The double entry for this transaction is debit the Motor Vehicle account and credit the Cash account.

3. Credit transactions are recorded in 2 adjusting ledger accounts

When the business buys or sells goods for resale, fixed assets, or items for short-term use which are expenses on credit, two adjusting ledger accounts are created.

Accounts Receivable account records the debit entry of money owed to the business by debtors. Accounts Payable account records the credit entry of money that the business owes to suppliers.

These two accounts fill the gap for money not being present at the point of the transaction. They are closed off with an entry on the opposite side when money is finally received or spent.

4. Returned goods and withdrawals are recorded in 3 adjusting ledger accounts

The ledger accounts Purchases, Sales and Capital do not have reversing entries occurring in them. This means that if the business returns goods to the supplier, the Purchases account is not credited. If a customer returns goods to the business, the Sales account is not debited. Also, if the owner withdraws money from the business for personal use, the Capital account is not debited.

Returns Outwards account records the credit of the Purchases account. Returns Inwards account records the debit of the Sales account. Drawings account records the debit of the Capital account.

5. Accruals and prepayments are recorded in 2 adjusting accounts

When money is owed or paid in advance for expenses, the adjusting accounts Accrued Expense or Prepaid Expense records the transaction. Learn more about the difference between accruals and accounts payable and the concept of prepayments.

Balancing off ledger accounts

After recording all transactions, each ledger account is balanced off. This means that the left and right sides are totalled. If one side is larger than the other, you have to subtract the smaller side from the larger side.

Put the difference under the smaller side so as to make the both sides even. This difference is brought down on the opposite side to show that the ledger account is still open. The balance goes to the next period for business to continue.

Conclusion

This simple guide to ledgers should give you the understanding of how the third step in the Accounting Cycle works. Learning the types, format, double entry system, and balancing off ledger accounts gives you the foundation you need for practising to record many transactions in a question. Then you are able to move on to the fourth step in the Accounting Cycle which is the Trial Balance.

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See also:

Accounting Cycle: Complete basic accounting in 8 steps

Debit and Credit: Simple view of in and out

Increase and decrease of ALICE accounts

Assets: Owned fixed and liquid items with a debit balance

Expenses: Spending that’s direct, indirect, operating and non-operating

Capital: Invested assets and the liquidity of a business

Journals: Complete 7 Day Books with 4 types of transactions

Liabilities: Owed long and short term items with a credit balance

Cash Book: How to record cash, bank and discounts

Income: Earned, unearned and contributed money

ALICE: Assets, Liabilities, Income, Capital, Expenses

Goods for resale: Stock, Purchases, Sales, Carriages and Returns