Bookkeeping – Ledgers and Journals (Lesson 3)
Accounting books refer to journals and ledgers.
Many bookkeepers are confused about how an entry is made to the books of record for a business. Well to more easily understand this, the bookkeeper needs to understand the difference between a journal and a ledger as they pertain to bookkeeping.
Many of us keep personal journals of life, diaries. A journal acts as a chronological order of events. Well a business journal is exactly the same thing. It is a date order of activity for a particular function. Ledgers are different though. Ledgers relate to the various accounts customarily found in the chart of accounts. A ledger tracks the activity in this account. A good example is your bank account. A ledger identifies the in’s and out’s within this account. Most often the order is by date but sometimes there may be an entry or two not date based but function based.
The following sections go into much more detail related to these two types of books, where they are found and who typically uses them. This lesson finishes up by explaining how modern accounting software incorporates these two types of sources of information into their processes.
Journals – Original Source of Entry
In Lesson 2 it was explained how Pacioli wrote about the dual entry process for accounting. His basis was the methods used by Renaissance merchants specifically the Venetian merchants selling their wares. What the merchant did was to take a journal with him to the market. When a customer purchased an item, he would record by date and the event the particular transaction. He simply stated he sold item X to customer C for a certain set sum of money. In addition, he recorded how he collected his money. Today this journal is called the Sales Journal.
A journal is merely a date sensitive log of activity for a particular function of business. There are about one dozen common journals used in accounting. The following are the more common journals found in business:
- Sales Journal
- Payroll Journal
- Purchases Journal
- Cash Disbursements Journal
- Inventory Received Journal
- Shipping Journal
- Deposit Journal
- Invoices Journal
- General Journal
A lot of beginners think that the journals are in the physical possession of the accountants or bookkeepers. In reality, they are controlled by the clerk in the respective departments. As an example, the sales department generates and controls the Sales Journal, shipping controls the Shipping Journal and so on. Some of the journals are kept by the accountants but most are out and about in the company where other parties are involved.
Also in Lesson 2, the dual entry system was introduced for accounting. This is where the dual entry starts. When the merchant recorded his entry, he basically records a sale as a credit and the cash collected as a debit. Just think of it visually with a ‘T’ account as described in Lesson 2. Once this entry is in the journal, he then transfers the entry to the respective ledgers.
Ledgers – Final Resting Place for Entry
A ledger is merely a line by line or row after row of information related to a particular account. The sales entry from above affects two ledgers. The first ledger is the sales account. One line of data is entered in this ledger with same date as the journal entry with the dollar value associated with that sale. The value is recorded in the Credit column as most sales are credits. A corresponding debit is recorded in the cash ledger in the Debit column.
Both entries are marked in the ledger from the Sales Journal with a simple SJ code that corresponds to the same date. The cash account ledger will look like this:
Date Source Description DR CR Balance
11/10/1429 SJ 1 Bag of Wheat 7.02 -0- 7.02
Remember the sales ledger will look exactly the same except the value will be a credit. The balance is a carry forward value from the prior line of information. In the sales journal a tick mark is given to that particular transaction indicating it is recorded and in modern day accounting there is an indicator for the particular lines of entry. In accounting it is referred to as the ‘Split Account’ i.e. the offsetting account. Thus, in the sales journal, there is a column labeled ‘Split’ and for this particular transaction the word ‘Sales’ is inserted in the ‘Split’ column and in the cash collected line the word ‘Cash’ is inserted. This way the reader knows which ledger the value was entered.
Seems pretty cumbersome doesn’t it? A lot of writing is needed to record a single economic transaction. But remember, back in those days it wasn’t like you had 3 – 5 million transactions per day like modern day Walmart. These were relatively low volume transactions but generated significant value to the merchant.
Believe it or not the use of journals and ledgers was quite common for small business right through the 80’s. Today accounting software resolves a lot of this automatically for us.
Modern Technology Application
There are several different small business accounting software packages on the market. Depending on the nature of your business and the corresponding volume of economic activity (number of transactions per day) determines which is best for your business. There are several articles related to accounting software and it is beneficial for you to visit the accounting systems and technology section of businessecon.org. One particular article is geared towards choosing the best software.
Overall, the author endorses QuickBooks for small business as you get the best bang for your buck.
Almost all the different software packages use the basic journal and ledger concept along with dual entry to record activity. In addition, the software limits access for certain individuals to just their respective function in the business. Thus, the sales clerk can’t explore the software and look at the payroll or the financial reports unless granted those rights.
Whenever a transaction is initiated, the information is automatically recorded in the respective journal along with all the necessary information. In some software packages you can require customer or other similar information for additional use. But in general, the journals are similar to the journals described above. The ledgers associated with the respective lines of entry are automatically updated and the bookkeeper doesn’t really have to do too much in entering the source data.
This doesn’t mean a bookkeeper isn’t needed, it just means that some functions are automatic for the operation.
An example is QuickBooks Retail and Accounting package. Here the retail sales transaction automatically updates the sales ledger and the corresponding cash ledger.
The real value for a bookkeeper is in keeping up with all the other traditional entries. These include paying the bills, running the payroll, balancing the books, reconciling the bank accounts and creating the close of period entries. The better bookkeepers can also keep up with the accrual adjustments for the business. These issues are explained and taught in future lessons. Just remember, technology inserts the information into the correct journals and ledgers at the point of the economic transaction. Therefore, you don’t have to worry about the cumbersome process of recording data in different journals and ledgers by hand.
Summary – Ledgers and Journals
Two key terms are used in accounting in referring to the sources and compiling of the data. The first is the source book of information and this is the journal. It is date driven and in chronological order. It is considered the actual dual entry point. Both sides of the equation are then transferred to the respective account ledgers as single lines of information with a balance carry forward. Journals do not have any balance information related to the entries. Journals simply record the entries. Ledgers identify the balance for the respective account. ACT ON KNOWLEDGE.
Do you want to learn how to get returns like this?
Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.
There are four key principles used with value investing. Each is required. They are:
- Risk Reduction – Buy only high quality stocks;
- Intrinsic Value – The underlying assets and operations are of good quality and performance;
- Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
- Patience – Allow time to work for the investor.
If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above.
Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:
- Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
- Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
- Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.
Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:
- Lessons about value investing and the principles involved;
- Free webinars from the author following up the lessons;
- Charts, graphs, tutorials, templates and resources to use when you create your own pool;
- Access to existing pools and their respective data models along with buy/sell triggers;
- Follow along with the investment fund and its weekly updates;
- White papers addressing financial principles and proper interpretation methods; AND
- Some simple good advice.