Monday, July 18, 2011

Subsidiary Ledger

Subsidiary Ledgers

A subsidiary ledger is a group of similar accounts whose combined balances equal the balance in a specific general ledger account. The general ledger account that summarizes a subsidiary ledger's account balances is called a control account or master account. For example, an accounts receivable subsidiary ledger (customers' subsidiary ledger) includes a separate account for each customer who makes credit purchases. The combined balance of every account in this subsidiary ledger equals the balance of accounts receivable in the general ledger. Posting a debit or credit to a subsidiary ledger account and also to a general ledger control account does not violate the rule that total debit and credit entries must balance because subsidiary ledger accounts are not part of the general ledger; they are supplemental accounts that provide the detail to support the balance in a control account.
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The accounts receivable subsidiary ledger is essential to most businesses. Companies may have hundreds or even thousands of customers who purchase items on credit, who make one or more payments for those items, and who sometimes return items or purchase additional items before they finish paying for prior purchases. Recording all credit purchases, returns, and subsequent payments in a single account would make an individual customer's balance virtually impossible to calculate because the customer's transactions would be interspersed among thousands of other transactions. But the accounts receivable subsidiary ledger provides quick access to each customer's balance and account activity.
Companies create subsidiary ledgers whenever they need to monitor the individual components of a controlling general ledger account. In addition to the accounts receivable subsidiary ledger, companies often use an accounts payable subsidiary ledger (creditors' subsidiary ledger), which has separate accounts for each creditor, an inventory subsidiary ledger, which has separate accounts for each product, and a property, plant, and equipment subsidiary ledger, which has separate accounts for each long-lived asset.

Special Journal


Special Journals 

In a typical 2-column manual accounting system, transactions are entered as debits to one (or more) account and balancing credits to one (or more) account. If you consider some recurring transactions (such as sales) that will hopefully occur many times during an accounting cycle, all this double entry can add up to a lot of work. That's where special journals come into play.
Special journals are designed as a simple way to record a single type of frequently occurring transaction. The types of special journals depends on the nature of the business, but a few types are frequently seen in businesses that rely on manual accounting procedures:
Sales Journal
Sales journals are used for recording sales of merchandise on account, aka credit sales. (Cash sales are not recorded here, they belong in the cash receipts journal.)
Since every sales entered in the sales journal will result in a debit to accounts receivable and a credit to the sales income account, it is not neccessary to repeat that information, or even both sides of the resulting journal entry in the sales journal. All that is required here is the date and amount of the sale and which customer is responsible for paying. This makes keeping the journal current very simple.
Sales Journal Examples
Consider, for example, that you make 5 credit sales transactions this month. In a 2-column manual accounting system, you would have 5 pairs of entries in your general journal that look like Figure A below.
(To see Figure A, click the A button in the flash program at the bottom of this page. This is where you'll find all the figures for this tutorial.)
That's 10 lines in your general journal. With the sales journal, however, you only have five lines as shown in Figure B below.
Posting from the Sales Journal
When you record credit sales in your sales journal, you post individual transactions to customer accounts in the accounts receivable ledger.
In your general ledger, you only need to post a single total to the Accounts Receivable and Sales accounts, as shown in Figure C.
Sales Returns and Allowances
When merchandise is sold and subsequently returned, or the seller grants an adjustment to price, this entry is recorded in the general journal.
(Remember, the sales journal is used for recording credit sales only. Sales returns are not credit sales, and do not fit into any of the special journals, so they go in the general journal.)
The debit portion of the transaction is recorded in the Sales Returns and Allowances account in the general ledger, while the credit portion is recorded in the Accounts Receivable account (as shown in Figure D below).
In the case of a cash refund, Sales Returns and Allowances is debited and Cash is credited (as shown in Figure D below). Also, since this transaction involves a cash payment, this entry would be recorded in the Cash Payments Journal.
Sales Journal Illustrations
The Sales Journal is a special journal designed to record a single type of frequently occurring transaction — in this case, credit sales. This tutorial covers the concept of the sales journal from the original transactions through the posting process.



Cash Receipts Journal
The Cash Receipts Journal is used to record sales of merchandise for cash. (Credit sales are not recorded here, they belong in the sales journal.)
All transactions in the cash receipts journal involve the receipt of cash, so you'll find a column for debiting cash (Cash DR.). There is also a debit column for sales discounts in case the transaction involves a sale that is discounted.
To balance these debits, you'll find three credit columns. Sales and Accounts Receivable are the two accounts that will mostly be involved in these transactions (besides cash, of course). The column for Other Accounts is for all other types of cash-receiving transactions that don't involve sales or accounts receivable.
See the columns available in the Cash Receipts Journal in Figure A below. (To see Figure A, click the A button in the flash program at the bottom of this page. This is where you'll find all the figures for this tutorial.)
Cash Receipts Journal Examples
Consider the following four examples for your cash receipts journal:
  • Customer A sends a check for a prior sale, paying $10,357.55 and taking a $102.55 sales discount;
  • You make a cash sale for $452;
  • Customer B sends a check for a prior sale, paying $6,120;
  • You are paid $3,000 in principal and $155 in interest on a note.
These transactions are posted to the cash receipts journal as shown in Figure A below.
Posting from the Cash Receipts Journal
The column values are posted in their own separate ways: 
  • Transactions from the Other Accounts column should be posted individually in the general ledger, as shown in Figure B below. (The account number for the general ledger account is placed in the posting column of the Cash Receipts Journal.)
  • Cash Sales recorded in the Cash Receipts Journal should be posted as a single Sales credit total in your general ledger, as shown in Figure C below.
  • Like cash sales, sales discounts should be posted as a single Sales Discounts credit total in your general ledger, as shown in Figure C below.
  • Cash should be posted as a single debit total in your general ledger, as shown in Figure D below.
  • When you record cash payments towards accounts receivables, you should post individual transactions as credits to the customer accounts in the accounts receivable ledger, as shown in Figure E below.

Cash Receipts Journal Illustrations
The Cash Receipts Journal is a special journal designed to record a single type of frequently occurring transaction — in this case, cash receipts. This tutorial will cover the concept of the cash receipts journal from the original transactions through the posting process.

Purchases Journal

The Purchases journal is used for recording credit purchases such as merchandise for resale to customers, business supplies, equipment, and other such purchases. (Cash purchases are not recorded here, they belong in the cash payments journal.)

Purchases Journal Examples

In Figure A below, you'll see five credit purchase transactions posted to the Purchasing Journal. Note that each transaction reflects a credit to Accounts Payable, and a debit to one or more debit accounts depending on the transaction.
(To see Figure A, click the A button in the flash progran at the bottom of this page. This is where you'll find all the figures for this tutorial.)

Posting from the Purchasing Journal

When you record credit purchases in your Purchasing Journal, the column values are posted like so:
  • Accounts Payable should be posted as a single credit total in your general ledger, as shown in Figure B.
  • Purchases recorded in the journal should be posted as a single debit total in your general ledger, as shown in Figure B.
  • Store Supplies and Office Supplies should be posted as single debit totals to your general ledger, as shown in Figure C.
  • All other transactions in the Other Accounts column should be posted individually in the general ledger, as shown in Figure D. (The posting reference column reflects the appropriate general ledger account number.)

Purchases Returns and Allowances

When merchandise purchased is subsequently returned, or the seller grants an adjustment to price, this entry is recorded in the general journal.
(Remember, the purchases journal is used for recording credit purchases only. Purchases returns are not credit purchases, and do not fit into any of the special journals, so they go in the general journal.)
The credit portion of the transaction is recorded in the Purchases Returns and Allowances account in the general journal, while the debit portion is recorded in the Accounts Payable account (as shown in Figure E below).
In the case of a non-merchandise return or allowance, Accounts Payable is credited. The account that was credited in the original transaction is debited (as shown in Figure E below).

Purchases Journal Illustrations

The Purchases Journal is a special journal designed to record a single type of frequently occurring transaction — in this case, credit purchases. This tutorial cover the concept of the purchases journal from the original transactions through the posting process.

Cash Payments Journal
The Cash Payments Journal is used to record all cash payments made by a company. (Credit purchases are not recorded here, they belong in the purchases journal.)
All transactions in the cash payments journal involve the disbursement of cash, so you'll find a column for crediting cash (Cash CR.). There is also a credit column for purchases discounts in case the transaction involves a discounted purchase.
To balance these credits, you'll find two debit columns. Accounts Payable is the account most likely to be involved in these transactions (besides cash). The column for Other Accounts is for all other types of cash-payment transactions that don't involve accounts payable.
See the columns available in the Cash Payments Journal in Figure A below. (To see Figure A, click the A button in the flash program at the bottom of this page. This is where you'll find all the figures for this tutorial.)
Cash Payments Journal Examples
Consider the following transactions for your cash payments journal:
  • Paid $455 for office equipment;
  • Paid $1,200 for purchases;
  • Paid $2,000 to Supplier A against accounts payable, taking a purchases discount of $225;
  • Paid $1,125 for purchases;
  • Paid $765.50 to Supplier B against accounts payable.
These transactions are posted in the cash payments journal as shown in Figure A below.
Posting from the Cash Payments Journal
The column values are posted in their own separate ways:
  • Transactions from the Other Accounts column should be posted individually in the general ledger, as shown in Figure B and Figure C below. (The account number for the general ledger account is placed in the posting column of the Cash Payments Journal.)
  • NOTE: You could combine the two Purchases entries in Figure C below into a single general ledger posting, but keeping them as separate entries will make it easier later on in case you have to hunt down any difficulties (such as balancing an unbalanced trial balance).
  • When you record cash payments against accounts payable, you should post individual transactions as debits to the supplier accounts in the accounts payable ledger. The accounts payable total at month's end is then posted in the general ledger, as shown in Figure D below.
  • Purchases discounts should be posted as a single Purchases Discounts credit total in your general ledger, as shown in Figure E below. (These should also be posted as credits to the corresponding supplier account in the accounts payable ledger).
  • Cash should be posted as a single credit total in your general ledger, as shown in Figure E below.
Cash Payments Journal Illustrations
The Cash Payments Journal is a special journal designed to record a single type of frequently occurring transaction — in this case, cash payments. This tutorial cover the concept of the cash payments journal from the original transactions through the posting process.










Although companies create special journals for other types of repetitive transactions, almost all merchandising companies use special journals for sales, purchases, cash receipts, and cash disbursements.


Sales journal. The sales journal lists all credit sales made to customers. Sales returns and cash sales are not recorded in this journal. Entries in the sales journal typically include the date, invoice number, customer name, and amount. Invoices are the source documents that provide this information. In its most basic form, a sales journal has only one column for recording transaction amounts. Each entry increases (debits) accounts receivable and increases (credits) sales.
Notice the dates and posting references applied to each entry in the illustration to the right. Each day, individual sales journal entries are posted to the accounts receivable subsidiary ledger accounts so that customer balances remain current. Customer account numbers (or check marks if customer accounts are simply kept in alphabetical order) are placed in the sales journal's reference column to indicate that the entries have been posted. At the end of the accounting period, the column total is posted to the accounts receivable and sales accounts in the general ledger. Account numbers are placed in parentheses below the column to indicate that the total has been posted.
Many companies use a multi-column (columnar) sales journal that provides separate columns for specific sales accounts and for sales tax payable. Each line in a multi-column journal must contain equal debits and credits. For example, the entries in the sales journal to the right appear below in a multi-column sales journal that tracks hardware sales, plumbing sales, wire sales, and sales tax payable. Individual entries are still posted daily to the accounts receivable subsidiary ledger accounts, and each column total is posted at the end of the accounting period to the appropriate general ledger account.





Purchases journal. The purchases journal lists all credit purchases of merchandise. Entries in this journal usually include the date of the entry, the name of the supplier, and the amount of the transaction. Some companies include columns to identify the invoice date and credit terms, thereby making the purchases journal a tool that helps the companies take advantage of discounts just before they expire. The purchases journal to the right has only one column for recording transaction amounts. Each entry increases (debits) purchases and increases (credits) accounts payable.
Each day, individual entries are posted to the accounts payable subsidiary ledger accounts. Creditor account numbers (or check marks if the creditor accounts are not numbered) are placed in the purchases journal's reference column to indicate that the entries have been posted. At the end of the accounting period, the column total is posted to purchases and accounts payable in the general ledger. Account numbers are placed in parentheses below the column to indicate that the total has been posted.
Companies that frequently make credit purchases of items other than merchandise use a multi-column purchases journal. For example, the purchases journal below includes columns for supplies and equipment. Of course, every purchase in the journal below must credit accounts payable; equipment purchased with a note payable or supplies purchased with cash would not be recorded in this journal. Individual entries are still posted daily to the accounts payable subsidiary ledger accounts, and each column total is posted at the end of the accounting period to the appropriate general ledger account.





Cash receipts journal. Transactions that increase cash are recorded in a multi-column cash receipts journal. If sales discounts are offered to customers, the journal includes a separate debit column for sales discounts. Credit columns for accounts receivable and for sales are normally present, but companies that frequently receive cash from other, specific sources use additional columns to record those types of cash receipts. In addition, the cash receipts journal includes a column named Other, which is used to record various types of cash receipts that occur infrequently and therefore do not warrant a separate column. For example, cash receipts from capital investments, bank loans, and interest revenues are generally recorded in the Other column. However, a company that provides consumer loans and receives interest payments from many customers would probably include a separate column for interest revenue. Whenever a credit entry affects accounts receivable or appears in the Other column, the specific account is identified in the column named Account.
Accounts receivable payments are posted daily to the individual subsidiary ledger accounts, and customer account numbers (or check marks if the customer accounts are not numbered) are placed in the cash receipts journal's reference column. At the end of the accounting period, each column total is posted to the general ledger account listed at the top of the column, and the account number is placed in parentheses below the total. Entries in the Other column are posted individually to the general ledger accounts affected, and the account numbers are placed in the cash receipts journal's reference column. A capital X is placed below the Other column to indicate that the column total cannot be posted to a general ledger account.

Accounting Concept

Accounting concept and conventions

In drawing up accounting statements, whether they are external "financial accounts" or internally-focused "management accounts", a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation.
The theory of accounting has, therefore, developed the concept of a "true and fair view". The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business' activities.
To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently.
Accounting Conventions
The most commonly encountered convention is the "historical cost convention". This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their original cost.
Under the "historical cost convention", therefore, no account is taken of changing prices in the economy.
The other conventions you will encounter in a set of accounts can be summarised as follows:
Monetary measurement
Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc.
Separate Entity
This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business.
Realisation
With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms.
Materiality
An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts.
Accounting Concepts
Four important accounting concepts underpin the preparation of any set of accounts:
Going Concern
Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important implications for the valuation of assets and liabilities.
Consistency
Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change.
Prudence
Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (the are "provided for" in the accounts" as soon as their is a reasonable chance that such costs will be incurred in the future.
Matching (or "Accruals")
Income should be properly "matched" with the expenses of a given accounting period.
Key Characteristics of Accounting Information
There is general agreement that, before it can be regarded as useful in satisfying the needs of various user groups, accounting information should satisfy the following criteria:
Criteria
What it means for the preparation of accounting information
Understandability
This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities
Relevance
This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)
Consistency
This implies consistent treatment of similar items and application of accounting policies
Comparability
This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.
Reliability
This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor).
Objectivity
This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest

Users of Information


Users of accounts

It is easy to assume that the only users of accounting information are shareholders - since it is a requirement of company law that shareholders must receive periodic accounting statements. However, in reality there are many users of accounts. The table below summarises the main user groups and provides examples of their areas of interest in accounts:
User
Interest in / Use of Accounting Information
Investors
Investors are concerned about risk and return in relation to their investments. They require information to decide whether they should continue to invest in a business. They also need to be able to assess whether a business will be able to pay dividends, and to measure the performance of the business' management overall. The key accounting information for an investor is therefore:
- Information about growth - sales, volumes
- Profitability (profit margins, overall level of profit)
- Investment (amounts invested, assets owned)
- Business value (share price)
- Comparative information of competitors
Lenders
Banks and loan stockholders who lend money to a business require information that helps them determined whether loans and interest will be paid when due. The key accounting information for lenders is therefore:
- Cash flow
- Security of assets against which the lending may be secured
- Investment requirements in the business
Creditors
Suppliers and trade creditors requirement information that helps them understand and assess the short-term liquidity of a business. Is the business able to pay short-term debt when it falls due? Creditors will, therefore, be looking for information on:
- Cash flow
- Management of working capital
- Payment policy
Debtors
Customers and trade debtors require information about the ability of the business to survive and prosper. As customers of the company's products, they have a long-term interest in the company's range of products and services. They may even be dependent on the business for certain products or services. Customer will be particularly interested in:
- Sales growth
- New product development
- Investment in the business (e.g. production capacity)
Employees
Employees (and organisations that represent them - e.g. trade unions) require information about the stability and continuing profitability of the business. They are crucially interested in information about employment prospects and the maintenance of pension funding and retirement benefits. They are also likely to interested in the pay and benefits obtained by senior management!. Employees will, therefore look for information on:
- Revenue and profit growth
- Levels of investment in the business
- Overall employment data (numbers employed, wage and salary costs)
- Status and valuation of company pension schemes / levels of company pension contribution


Government
There are many government agencies and departments that are interested in accounting information. For example, the Inland Revenue needs information on business profitability in order to levy and collect Corporation Tax. Customs & Excise need accounting information to verify Value Added Tax ("VAT") returns; local government need similar information to levy local taxes and rates. Various regulatory agencies (e.g. the Competition Commission and the Environment Agency) need information to support decisions about takeovers and grants, for example.
Analysts
Investment analysts are an important user group - specifically for companies quoted on a stock exchange. They require very detailed financial and other information in order to analyse the competitive performance of a business and its sector. Much of this is provided by the detailed accounting disclosures that are required by authorities such the London Stock Exchange. However, additional accounting information is usually provided to analysts via informal company briefings and interviews.
Public at large
Interest groups, formed by various groups of individuals who have a specific interest in the activities and performance of businesses, will also require accounting information.

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