ICAEW - Accounting 2020 - Chap 4

CFAB
ACCOUNTING
CHAPTER 4
LEDGER ACCOUNTING
& DOUBLE ENTRY
BUSINESS WITH CONFIDENCE icaew.com
Chapter 4 – Topic list
1. Ledgers
2. The nominal ledger
3. The double entry bookkeeping
4. Journal entries
5. Double entries for petty cash
6. The receivables and payables ledgers
7. Accounting for discounts
8. Accounting for VAT

1. Ledgers
Source documents
Journals
/ Books of original entry
Ledger
Trial balance
Financial statement

1. Ledgers

1. Ledgers
1.1. Use of ledgers
 “Ledger” means “book”
 Ledgers are use to record and analyze the transactions undertaken.
 When the time comes to prepare the financial statements, the relevant
information can be easily extracted from the ledgers.
 The transactions in ledger accounts should be recorded:
 In a chronological order and dated so that transactions can be
related to a particular period of time.
 Built up in cumulative totals
o Day by day
o Week by week
o Month by month
o Year by year

1. Ledgers
1.1. Use of ledgers
Nominal ledger
Containing a separate ledger account
(usually a page of the book) for each type
of income, expense, asset, liability and
capital.
Receivables ledger
Ledgers Containing a separate ledger account for
each credit customer.
Payables ledger
Containing a separate ledger account for
each credit supplier.

2.1. What is the nominal ledgers used for?
 Nominal ledger
 The main accounting record in which financial transactions are
recorded.
 Containing details of assets, liabilities, capital, income and expenditure,
and therefore profit or loss.
 Consisting a large number of different ledger accounts (each account
having their own purpose or name and an identity or code).
 Each ledger account is assigned a unique code.
 The codes are assigned in such a way that related or similar ledger
account will have consistent coding (belonging to a same category).
 Example:
o 100000 – Administrative expenses
o 100100 – Telephone expenses
o 100200 – Rent expenses

 Ledger accounts in the nominal ledger may include:
 Plant and machinery at cost (NCA)
 Motor vehicles at cost (NCA)
 Plant and machinery, accumulated depreciation (deduction from NCA)
 Motor vehicles, accumulated depreciation (deduction from NCA)
 Owner’s capital (capital)
 Inventories – Raw materials (CA)
 Inventories – finished goods (CA)
 Total trade receivables (CA)
 Total trade payables (CA)
 Wages and salaries (expense)
 Rent and local taxes (expense)
 Advertising expenses (expense)
 Bank charges (expense)
 Motor expenses (expense)
 Telephone expenses (expense)
 Sales (income)
 Total cash/bank overdraft (current asset/liability)


2.2. The format of a ledger account
 Ledger account has the T-account format.
Name of account
£ £
Debit side Credit side
“Debits are on the left, credits are on the right”

 An accounting record in a ledger account captures:
 The date
 A brief description
 A unique reference
ADVERTISING EXPENSES
Date Narrative Ref. £ Date Narrative Ref. £
JFK Agency
20X6 for quarter PL348 2,500
to 31 Mar

3. Double entry bookkeeping
3.1. Dual effect (duality concept)
 Each transaction has two effects, equal but opposite (duality concept)
 Every accounting event must be entered in ledger accounts both as a
debit and a credit.
 Double entry bookkeeping is the method used to record transactions in
the nominal ledger accounts.
 Central to double entry bookkeeping is the duality concept.
 Every transaction is recorded twice in the ledger accounts.


Example:
 If the business were to buy a car for £1,000, the business would be
affected in two ways:
 The business owns a car (an asset) worth £1,000.
 The business have £1,000 less cash (an asset).
 If instead the business got a bank loan to buy the car:
 The business owns a car (an asset) worth £1,000.
 The business owe the bank £1,000 (a liability).
 A month later if the business pay a garage £50 to have the exhaust
repaired.
 The business have £50 less cash (an asset).
 The business has incurred a repairs expense of £50 (an expense).

3.2. The rule of double entry bookkeeping



Example: Debits and credits (Study manual, page 91)
a. Purchase of books on credit
Payables increase CREDIT Payables (increase in liability)

Purchases increase DEBIT Purchases (increase in expenses)
b. Purchase of cash register by cheque
Own a cash register DEBIT Non-current asset (increase in asset)

Cash at bank decreases CREDIT Cash at bank (decrease in asset)
c. Payment received from a credit

customer
Receivables decrease
Cash at bank account
d. Sell books for cash
Revenue increase
Cash at bank account increases

3.3. Double entry for cash transactions
 Cash at bank account is the nominal ledger account in which receipts
and payments of cash are recorded, or posted, from the book of original
entry (the cash at bank book).
 Cash payment
 A credit entry in the cash at bank account.
 The matching debit entry is made in the appropriate expense or
assets account.
 Cash receipt
 A debit entry in the cash at bank account.
 The matching credit entry is made in appropriate revenue (income)
account.

Example: Cash transactions (Study manual, page 91)
A business has the following transactions:
a. Receive £250 in respect of a cash sale
b. Pay a rent bill totaling £150
c. Pay £100 cash for goods
d. Pay £200 cash for shelves
Record these transactions in the nominal ledgers accounts.
Each transactions will be posted twice.

a. Receive £250 in respect of a cash sale
Cash at bank
Date Narrative Ref. Date Narrative Ref. £
Sale 250
Sales
Cash
receipt 250

b. Pay a rent bill totaling £150
Rent Expenses
Cash
150
payment
Cash at bank
Rent
150
Expenses

c. Pay £100 cash for goods
Purchase
Cash at
100
bank
Cash at bank
Purchases 100

d. Pay £200 cash for shelves
Shelves
Cash at
200
bank
Cash at bank
Shelves 200

3.4. Double entry for credit transactions
 Trade payables account
 When a business acquires goods or services on credit, the credit
entry is post to the “trade payables account” instead of the cash
account.
 The corresponding debit entry is posted to the expense or asset
account.
 Trade receivables account
 When a sale is made to a credit customer, the entry is debit to the
“trade receivables account” (instead of cash account)
 The corresponding credit entry is posted to the sales account.

Example: Double entry for credit transactions (Study manual, page 93)
A business entered into the following transactions:
a. The business sells goods on credit to Mr. A for £2,000.
b. The business buys goods on credit from B Ltd for £100.
How and where are these transactions posted in the ledger accounts?

a. The business sells goods on credit to Mr. A for £2,000.

b. The business buys goods on credit from B Ltd for £100.

3.4.1. Double entry when cash is paid by credit customers or to credit
suppliers
Continuing the example above:
a. The business paid £100 to B Ltd one month after the goods were
acquired.

suppliers
a. The business paid £100 to B Ltd one month after the goods were
acquired.
We now bring all together

suppliers
b. Mr. A pays his debt of £2,000.

suppliers
b. Mr. A pays his debt of £2,000.
We now bring all together

suppliers

suppliers
Example: Debits and credits (Study manual, page 95)
Identify the debit and credit entries in the following transaction (ignore VAT)
(a) Bought a machine on credit from A, cost £8,000.
(b) Bought goods on credit from B, cost £500.
(c) Sold goods on credit to C, value £1,200.
(d) Paid D (a credit supplier) £300.
(e) Collected £180 from E, a credit customer.
(f) Paid net pay £4,000.
(g) Received rent bill of£700 from landlord G.
(h) Paid rent of £700 to landlord G.
(i) Paid insurance premium £90.

3.4.1. Double entry when cash is paid by credit customers or to credit suppliers
Example: Ledger entries (Study manual, page 95)
Ron Knuckle set up a business selling fitness equipment. He put £7,000 of his own
money into a business bank account (transaction A) and in his first period of trading,
the following transactions occurred.
Transaction £
B Paid rent of shop for the period 3,500
C Purchased equipment (inventories) on credit 5,000
D Loan from bank 1,000
E Purchase of shop fittings (for cash) 2,000
F Sales of equipment: cash 10,000
G Sales of equipment: on credit 2,500
H Payment to credit suppliers 5,000
I Receipts from credit customers 2,500
J Interest on loan (paid) 100
KBUSINESS Other expenses (all paid in cash)
WITH CONFIDENCE 1,900
icaew.com
L Drawings 1,500
Prepare the ledger accounts for Ron Knuckle by opening up the following accounts
and completing them:
 Cash at bank  Sales
 Capital  Trade receivables
 Loan  Purchases
 Trade payables  Loan interest
 Rent  Other expenses
 Shop fittings  Drawings

CASH AT BANK

CAPITAL
BANK LOAN

PURCHASES
TRADE PAYABLES

RENT
SHOP FITTINGS

SALES
TRADE RECEIVABLES

BANK LOAN INTEREST
OTHER EXPENSES

DRAWINGS

4. Journal entries
4.1. What are journal entries used for?
 A journal entry is a way of presenting the required double entry for a
transaction.
 Any transaction can be represented by a journal entry.
 Whatever type of transaction is being recorded, the format of a journal
entry is as follows.
Date Debit Credit
£ £
Account to be debited X
Account to be credited X
Narrative to explain the transaction
 The narrative should accompany each journal entry. It is required for
audit and control, to indicate the purpose and authority of every
transaction.
 A computerized accounting system will not allow a journal entry to be
processed if the debit entries do not equal the credit entries.

4. Journal entries
Example: Journal entries to record transactions (Study manual, page 97)
1 January Put in cash of £20,000 as capital
Purchased fixtures and fittings for cash of £5,000
Purchased equipment on credit for £2,000
30 January Paid three month rent to 31 March £1,500
Collected and paid in takings £600
31 January Gave a regular customer a hair treatment for £80 on credit
31 January Took out £100 for personal expenses

4. Journal entries
Example: Journal entries to record transactions (Study manual, page 97)
1 January
1 January
1 January
30 January
30 January
31 January
31 January
5. Double entry for petty cash
5.1. Double entry for petty cash transaction
 At the end of the month (or any other suitable interval) the total
payments in the petty cash book are posted to the appropriate
nominal ledger accounts.

 A business starts with a cash float (imprest system) on 1.3.20X7 of £250.
 Suppose five payments were made out of petty cash during March 20X7,
none of which attached VAT.
 The petty cash book is as follows:
Receipts Date Narrative Total payments Postage Travel
£ £
250.0 1.3.X7 Cash
2.3.X7 Stamps 12.0 12.0
8.3.X7 Stamps 10.0 10.0
19.3.X7 Travel 16.0 16.0
23.3.X7 Travel 5.0 5.0
28.3.X7 Stamps 11.5 11.5
250.0 54.5 33.5 21.0

At the end of March
Debit Credit
£ £
DEBIT Postage 33.5
DEBIT Travel 21.0
CREDIT Petty cash 54.5
The cash float needs to be topped up to the imprest amount by a payment of

£54.5 from the business bank account
Debit Credit
£ £
DEBIT Petty cash 54.5
CREDIT Cash at bank 54.5

Petty cash book
Receipts Date Narrative Total payments Postage Travel
£ £
250.0 1.3.X7 Cash
2.3.X7 Stamps 12.0 12.0
8.3.X7 Stamps 10.0 10.0
19.3.X7 Travel 16.0 16.0
23.3.X7 Travel 5.0 5.0
28.3.X7 Stamps 11.5 11.5
31.3.X7 Balance carried down (c/d) 195.5
250.0 250.0 33.5 21.0
195.5 1.4.X7 Balance brought down (b/d)
54.5 1.4.X7 Cash

PETTY CASH
20X7 20X7
1.3 Cash 250.0 31.3 Payments 54.5
1.4 Cash 54.5 1.4 Balance c/d 250.0
304.5 304.5
1.4 Balance b/d 250.0

6.1. Nominal ledger accounts and personal account
 Nominal ledger account
 Relating to types of income, expense, asset, capital and liability.
 Not record individual details of the customers or the supplier.
 Personal accounts
 Most commonly for receivables and payables
 Contained in the receivables ledger and the payables ledger.
 These are memorandum accounts only.
 They are not part of the double entry system.
 Trade receivables and trade payables account are kept in the nominal
ledger which record the totals of the receivables and payables ledgers.
 The total of the individual accounts in the receivables (payables) ledger at
any point in time will be exactly equal to the total included in trade
receivables (payables).


The need for a personal account for each customer
 Be able to tell a customer how much they currently owe
 It is a common practice to send out statements to credit customers at the
end of each month, showing:
 how much they owe, and
 itemizing new invoices or credit notes sent out
 payments received during the month.
 To check the credit position of individual customers
 To match payments received against debts owed

7.1. Trade discount
 Trade discount: a percentage discount deducted from the list price of
goods owing to the nature of the trading transaction.
 Trade discounts received should be deducted from the gross cost of
purchases by the supplier
 The cost of purchases in the payables ledger will be stated at the
invoiced amount
 Trade discounts given/allowed should be deducted from the gross
sales price by the business.
 Revenue will be reported at invoice value net of trade discount.
 There is no separate ledger account for trade discount.
 Accounting for trade discount
 Purchases should be recorded net of trade discounts received
from suppliers.
 Sales should be recorded net of trade discounts allowed/given to
customers.

7.2. Early settlement discount
 Early settlement discount (prompt payment discount, cash discount): a
percentage reduction in the amount payable in return for payment within
an agreed period.
 Early settlement discounts are offered to credit customer to encourage
them to settle amounts owed more quickly.

7.2.1. Accounting for early settlement discount offered to the
customers
 Sales should be recorded net of early settlement discounts taken by
customers.
 At the point of invoice when the sale is recorded, the business should
determine whether they expect the customer take the discount based on
its historical data.
 When payment is made, if the customer doesn’t behave as expected,
the accounting records are adjusted to reflect the full gross value of the
goods sold.

customers
Example: Study manual, page 102
 Finnie has normal credit term of 30 days but offers a prompt payment
discount of 5% to customers if they settle invoices within 10 days.
 On 19 April, Finnie sold goods totaling £500 to Ruby. Ruby normally takes
advantage of the prompt payment discount offered.
 On 22 April, Finnie sold goods to Sarah totaling £340. Sarah normally
takes a full 30 days to settle her invoices.
Requirement:
Record the transactions in the ledger accounts of Finnie assuming that:
i. Ruby pays within 10 days as expected.
ii. Ruby pays in more than 10 days.
iii. Sarah pays after 30 days as expected.
iv. Sarah pays within 10 days.

customers
a. Accounting for transactions with Ruby
i. DR Receivables 475
CR Revenue 475
DR Purchases 475
CR Payables 475
DR Cash 475
CR Receiv. 475
DR Payables 475
CR Cash 475
ii. DR Receivables 475
CR Revenue 475
DR Purchases 475
CR Payables 475
DR Cash 500
CR Receiv. 475
CR Revenue 25
DR Payables 475
DR Purchases 25
CR Cash 500
customers
a. Accounting for transactions with Ruby

customers
b. Accounting for transactions with Sarah
i. DR Receivables 340
CR Revenue 340
DR Cash 340
CR Receiv. 340
ii. DR Receivables 340

CR Revenue 340
DR Cash 323
DR Revenue 17
CR Receiv. 340
7.2.2. Accounting for early settlement discount received from suppliers
 Consistent with the approach applied to early settlement discount offered
to customers.
 Any early settlement discount received is offsets against purchases or
other appropriate expense category.
 A judgement should be made when the invoice is recorded as to whether
or not the business is likely to take advantage of early settlement discount
offered.

7.2.2. Accounting for early settlement discount received from suppliers
Continuing the above example, prepare Ruby’s ledger accounts to show how
Ruby would record the purchase transaction assuming that she expected to
take advantage of the early settlement but then did not pay within 10 days

8.1. What is VAT?
 Value added tax (VAT) is an indirect tax on the supply of goods
and services.
 Tax is collected at each point in the chain from prime producer to
final customer.
 Eventually, the consumer bears the tax in full and any tax paid
earlier in the chain can be recovered by a registered trader who
paid it.

8.1. What is VAT?

8.2. How VAT is collected?
 VAT is collected and paid by the traders who make up the chain:
 He must collect and pay over VAT on the full sales value (output
tax) of the goods sold.
 He is normally entitled to reclaim VAT paid on his own
purchases (input tax).
=> He will make a net payment to the HMRC (the tax on value added
by himself).

8.2. How VAT is collected?
VAT
Indirect tax
Input tax Output tax

The business suffers The business charges
trade tax on purchases tax on sales
 Output tax > input tax

The business pays the difference in tax to the authorities.
 Output tax < input tax
Tax authorities will refund the difference to the business.
8.3. Registered and non-registered traders
 Traders whose sales (outputs) are below a certain level need not register
for VAT.
 Unregistered traders neither charge VAT on their output nor are entitled to
reclaim VAT on their inputs => Their position is the same as a final
customer.
 All outputs of registered traders are either taxable or exempt.
 Traders carrying on exempt activities cannot charge VAT on their
outputs and consequently cannot reclaim VAT paid on their inputs.
 Traders carrying on taxable activities are entitled to reclaim VAT paid
on their inputs.
 Traders carrying on a mixture a taxable and exempt activities need to
apportion the VAT suffered on inputs and can usually only reclaim the
proportion of input tax that relates to taxable outputs

8.3. Registered and non-registered traders
 Taxable outputs are chargeable at on of three rates:
 Zero rate - 0% (e.g. on printed books and newspapers)
 Reduced rate - 5% (e.g. on domestic fuel)
 Standard rate – 20%

8.4. Accounting for VAT
 Recoverable VAT
 VAT should not be included in income or expenses (because VAT
can be recoverable).
 Irrecoverable VAT
 Where the trader suffers irrecoverable VAT as a cost, VAT should be
included as an expense (and cannot be claimed as input tax).
 Non-registered traders
o Suffering VAT on inputs as a cost.
o This will increase their expenses and the cost of any NCA they
purchase.
 Registered traders
o Who carrying on exempted activities may suffer VAT on certain
inputs.
o This will increase the expense in respect of these inputs.

8.4. Accounting for VAT
 Non-deductible inputs
 VAT on non-deductible inputs will be borne by all traders.
 VAT on cars purchased and use in the business is not reclaimable
(VAT on a car acquired new for resale by a car trader is reclaimable).
o Example:
o A business pays $5,000 for a motor vehicle & suffers
irrecoverable input sales tax of $400.
o The business therefore capitalize the full amount of $5,400 as
a NCA in the SOFP
 VAT on business entertaining is not deductible as input tax other
than VAT on entertaining staff.
o Example:
o A business pays $500 for entertaining expenses and suffers
irrecoverable input sales tax of $75 on this amount.
o Hence the total of $575 paid should be charged to the SOPL
as an expense.
8.5. VAT and discounts
 Trade discount
 If a trade discount is given, VAT is charged on the sale amount
net of the trade discount.
 Early settlement discount
 If an early settlement discount is offered at the point of sale,
output VAT is accounted for on the amount that is actually
received from the customer.
 Two options for a business when preparing an invoice that
includes early settlement discounts and VAT
 The supplier issues an invoice with VAT ignoring any offered early
settlement discount. If the customer takes up the discount, the
supplier issues a credit note for the amount of the discount
including the VAT.
 The supplier issues an invoice which states full amount including
any VAT and a footnote which details the term of the early
settlement discount and the related VAT.
8.6. VAT and irrecoverable debts
 Most registered persons are obliged to record VAT when a supply
is made or received (effectively when a sales invoice is raised or a
purchase invoice recorded).
 Output tax has to be paid to HMRC before it has al been received
from customers.
 If an amount due from a customer is subsequently written off as
irrecoverable, the VAT element may not be recoverable from HMRC
for some time after the sale.
 HMRC allow businesses to reclaim VAT on the bad debt. This
policy is called VAT bad debt relief (Vietnam doesn’t allow this
treatment).
 For more information:
https://www.gov.uk/guidance/relief-from-vat-on-bad-debts-notice-70018

8.7. Summary of accounting entries for VAT

8.7. Summary of accounting entries for VAT

8.8. Calculating VAT from a gross amount
Example: VAT (Study manual, page 110)
Mussel is preparing financial statements for the year ended 31 May 20X9.
Included in its statement of financial position as at 31 May 20X8 was a balance for
VAT due from HMRC of £15,000.
Mussel’s summary statement of profit or loss for the year to 31 May 20X9 is as
follows:
£’000
Sales (net) (all standard rated) 500
Purchases (net) (all standard rated) (120)
Gross profit 380
Expense (see note) (280)
Net profit 100
Note: Expenses £’000

Wages and salaries (exempt of VAT) 162
Entertainment expenditure (£40 + irrecoverable VAT £8) 48
Other (net) (all standard rated at 20%) 70
280
8.8. Calculating VAT from a gross amount
Example: VAT (Study manual, page 110)
VAT payments of 5,000, 15,000 and 20,000 have been made in the year to HMRC
and a repayment of 12,000 was received.
Requirement
What is the balance for VAT in the SOFP as at 31 May 20X9?
Hint: Use T-account for VAT

Chapter 4 - Summary
Study manual, page 111

Chapter 4 - Practice
Self-test – Study manual, page 112

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BUSINESS WITH CONFIDENCE icaew.com

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“Debits are on the left, credits are on the right”

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a. Purchase of books on credit

Payables increase CREDIT Payables (increase in liability)

b. Purchase of cash register by cheque

Own a cash register DEBIT Non-current asset (increase in asset)

c. Payment received from a credit

d. Sell books for cash

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