interpret ledger accounts and their balances

IGCSE Accounting (0452) – Interpreting Ledger Accounts and Their Balances

Learning Objectives

• Explain the purpose of accounting and the fundamental accounting equation.
• Identify source documents, record transactions in the appropriate books of prime entry and post them to the ledger.
• Understand the structure of the ledger (sales, purchases, nominal and control accounts) and the normal balance of each account type.
• Prepare a trial balance, recognise its uses and limitations, and correct common errors.
• Apply basic accounting procedures – depreciation (including revaluation), accruals, pre‑payments, doubtful and irrecoverable debts, and inventory valuation (FIFO & weighted‑average).
• Produce the principal financial statements for sole traders, partnerships, limited companies and non‑profits.
• Analyse financial information using key ratios and evaluate the relevance of accounting principles and policies.

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1 Fundamentals of Accounting

1.1 Purpose of Accounting

Accounting provides information for three main groups of users:

1. Owners/Managers – to measure profit, control costs and plan future activities.
2. External users (investors, creditors, tax authorities, etc.) – to assess the entity’s financial health and make decisions.
3. Society – to ensure transparency, accountability and compliance with legislation.

1.2 The Accounting Equation & Double‑Entry

• Accounting equation: Assets = Liabilities + Capital
• Every transaction affects at least two accounts – one debit and one credit.
• Normal balance:
  • Assets & expenses – Debit (Dr)
  • Liabilities, capital & revenue – Credit (Cr)

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2 Sources and Recording of Data

2.1 Source Documents

Document	Typical Use	Key Information Required
Invoice (sales/purchase)	Credit sale or purchase	Date, parties, description, amount, VAT, trade discount, cash discount (if any)
Receipt	Cash received	Date, payer, amount, purpose
Bank statement	Bank transactions	Date, description, amount (deposits/withdrawals), bank charges, interest
Credit / Debit note	Adjustments to a previous invoice	Reference to original invoice, reason, corrected amount
Petty‑cash voucher	Small cash payments	Date, item, amount, authorising signature

2.2 Books of Prime Entry – Purpose & Typical Entries

Book	Purpose	Typical Entries (example)
Cash book	Records all cash receipts and payments (and often bank transactions)	Dr Cash $1 200 – Cr Sales $1 200 (cash sale)
Sales journal	Records all credit sales of goods	Dr Debtors $2 500 – Cr Sales $2 500 (sale on credit)
Purchases journal	Records all credit purchases of goods	Dr Purchases $1 800 – Cr Creditors $1 800 (goods bought on credit)
Returns journals	Sales returns (debit) and purchase returns (credit)	Dr Sales Returns $300 – Cr Debtors $300 (customer returns goods)
General journal	All other transactions – depreciation, accruals, corrections, etc.	Dr Depreciation expense $500 – Cr Accumulated depreciation $500
Petty‑cash book (imprest system)	Tracks small cash outgoings; replenished to a fixed imprest amount	Dr Office supplies $45 – Cr Cash $45 (petty‑cash payment)

2.3 Ledger Structure

• Sales ledger (Debtors) – individual customer accounts plus a control account (Sales Ledger Control).
• Purchases ledger (Creditors) – individual supplier accounts plus a control account (Purchases Ledger Control).
• Nominal ledger – all revenue, expense, gain and loss accounts.
• Control accounts – summarise the total of a subsidiary ledger and link it to the general ledger.

2.4 Trade Discount vs. Cash Discount

Discount type	When applied	Journal entry
Trade discount	When the seller offers a reduction on the list price before the invoice is issued.	Dr Debtors $900 (net of 10% trade discount on $1 000) Cr Sales $900
Cash discount	When the buyer pays within an agreed period (e.g., 2% if paid within 10 days).	Dr Cash $980 Dr Discount received $20 Cr Debtors $1 000

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3 Posting to the Ledger

3.1 T‑Account Format & Normal Balances

A T‑account has a Debit (left) side and a Credit (right) side. The side on which the balance normally lies is the account’s normal balance (see Section 1.2).

3.2 Example – Posting a Credit Sale with Trade Discount

Journal entry (sales journal)
Date: 12 Mar
Customer: Beta Ltd
Invoice No.: S045
List price: $1 200
Trade discount 10% → Net amount $1 080

Dr Debtors $1 080
   Cr Sales $1 080

Ledger posting:

Debtors (Asset)	Sales (Revenue)
Dr $1 080	Cr $1 080

3.3 Control Account Example – Purchases Ledger Control

Purchases Ledger Control (Liability)	Supplier – Alpha Co.
Cr $2 500 (total purchases on credit)	Dr $2 500 (individual supplier entry)

The control account balances the total of all individual creditor accounts and is posted to the General Ledger.

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4 Trial Balance – Uses, Limitations & Corrections

4.1 Purpose & Uses of a Trial Balance

• Lists the closing balance of every ledger account in two columns (Debit | Credit).
• Primary use: verify that total debits equal total credits – an indication of arithmetic accuracy.
• Provides the starting point for preparing the Statement of Financial Position and the Income Statement.

4.2 Limitations (What a Trial Balance Cannot Detect)

• Errors of omission – a transaction is completely left out.
• Errors of commission – correct amount entered, but in the wrong account.
• Errors of principle – a transaction recorded in an inappropriate account type.
• Compensating errors – two or more mistakes that offset each other.
• Transposition errors that happen to balance (e.g., $540 recorded as $450 and another $90 error elsewhere).

4.3 Correcting a Trial Balance – Example (Commission Error)

Suppose a purchase of $1 200 was mistakenly recorded as $1 020 (a commission error). The trial balance still balances.

Incorrect journal entry
Dr Purchases $1 020
   Cr Creditors $1 020

Correction:

Dr Purchases $180
   Cr Creditors $180

After the correcting entry the balances of the affected accounts are restored to their true amounts.

4.4 Errors That Do Not Affect the Trial Balance

Error type	Why it does not affect the trial balance
Omission	No entry at all – nothing to total.
Commission	Same amount debited and credited, just the wrong figure.
Principle	Correct amount on both sides, but in the wrong account class.
Compensating	Two mistakes offset each other, keeping totals equal.

4.5 Suspense Account

• Used temporarily when the trial balance does not balance.
• All unresolved differences are posted to a Suspense Account (normally a debit balance).
• When the cause is identified, the suspense entry is reversed and the correct accounts are adjusted.

4.6 Bank Reconciliation – Aligning Cash Book with Bank Statement

Bank reconciliation item	Adjustment to cash book
Outstanding cheques	Deduct from bank balance
Deposits not yet credited	Add to bank balance
Bank charges	Dr Bank charges expense – Cr Cash
Interest received	Dr Cash – Cr Interest income

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5 Accounting Procedures

5.1 Capital vs. Revenue Expenditure

• Capital expenditure creates or enhances a long‑term asset; recorded as an asset and depreciated.
• Revenue expenditure maintains the earning capacity of existing assets; recorded as an expense in the period incurred.

5.2 Depreciation – Three Methods

Method	Formula	Typical Use
Straight‑line	(Cost – Residual value) ÷ Useful life	Most common for plant & equipment
Reducing balance	Opening NBV × Depreciation rate	When an asset loses value faster in early years
Revaluation (or re‑valuation) method	Depreciation based on the re‑valued amount (new fair value) – Residual value ÷ Remaining life	Used when an asset is re‑valued upwards during the year

Journal entry for annual depreciation (any method):

Dr Depreciation expense      XXX
   Cr Accumulated depreciation – [Asset]   XXX

5.3 Irrecoverable Debts & Provision for Doubtful Debts

• Irrecoverable debt – a specific debtor is known to be uncollectible.
• Provision for doubtful debts – an estimate of future uncollectible amounts.

Creating the provision (end‑of‑period adjustment)

Dr Bad‑debt expense          XXX
   Cr Provision for doubtful debts   XXX

Writing off a specific irrecoverable debt

Dr Provision for doubtful debts   YYY
   Cr Debtors (Accounts receivable)   YYY

Recovering a debt that was previously written off

Dr Debtors                     ZZZ
   Cr Provision for doubtful debts   ZZZ
   Cr Bad‑debt recovery (income)      ZZZ   (if any)

5.4 Accruals & Pre‑payments – Both Expenses and Income

Item	Initial entry (when cash is received/paid)	Adjusting entry at period‑end
Accrued expense (e.g., wages payable)	Dr Cash $5 000 – Cr Revenue $5 000 (if paid in advance) – *or* no entry if not yet paid	Dr Wages expense $5 000 – Cr Accrued wages $5 000
Accrued income (e.g., interest earned but not yet received)	— (no cash entry yet)	Dr Accrued interest receivable $300 – Cr Interest income $300
Prepaid expense (e.g., insurance paid for 12 months)	Dr Prepaid insurance $1 200 – Cr Cash $1 200	Each month: Dr Insurance expense $100 – Cr Prepaid insurance $100
Prepaid income (e.g., rent received in advance)	Dr Cash $2 400 – Cr Unearned rent (liability) $2 400	Each month: Dr Unearned rent $200 – Cr Rent income $200

5.5 Inventory Valuation

• Inventories are valued at the lower of cost or net realisable value (NRV).
• Cost determination methods required by the syllabus:
  • FIFO (First‑In‑First‑Out) – the earliest purchases are considered sold first.
  • Weighted‑average cost – average cost = (Total cost of opening stock + purchases) ÷ (Opening quantity + purchases quantity).

Example – FIFO

Opening stock: 100 units @ $5 = $500
Purchases: 150 units @ $6 = $900
Sales: 180 units

FIFO cost of goods sold = (100 × $5) + (80 × $6) = $500 + $480 = $980
Closing stock = 70 units @ $6 = $420

Example – Weighted‑average

Total cost = $500 + $900 = $1 400
Total units = 100 + 150 = 250
Average cost per unit = $1 400 ÷ 250 = $5.60

COGS (180 units) = 180 × $5.60 = $1 008
Closing stock (70 units) = 70 × $5.60 = $392

5.6 Other Common Procedures

• Bad‑debt expense – recorded when a debt is written off without a provision.
• Depreciation on revalued assets – recalculate depreciation each year on the new carrying amount.
• Imprest system for petty cash – maintain a fixed cash float; replenish by recording the total of vouchers and crediting Cash.

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6 Financial Statements Overview

6.1 Sole Trader & Partnership

• Statement of Financial Position – Assets, Liabilities, Capital (or Partners’ capital accounts).
• Income Statement (Profit & Loss Account) – Revenue, Cost of Goods Sold, Expenses, Net profit.

6.2 Limited Company

• Balance Sheet includes Share Capital, Share Premium, Reserves and Retained earnings.
• Income Statement includes Interest expense and Tax.
• Statutory notes (e.g., share‑holding pattern) are required in exams.

6.3 Non‑profit (Clubs & Societies)

• Statement of Financial Position – assets, liabilities, fund balance.
• Income & Expenditure Account – shows surplus or deficit for the year.

6.4 Manufacturing Business – Cost of Goods Manufactured (COGM)

Opening Raw Materials
+ Purchases of Raw Materials
+ Direct labour
+ Manufacturing overhead
– Closing Raw Materials
= Cost of Materials Used

Add: Direct labour + Overhead
= Total manufacturing cost
+ Opening Work‑in‑Progress
– Closing Work‑in‑Progress
= Cost of Goods Manufactured

6.5 Incomplete Records (Single‑Entry System)

• Reconstruct missing entries using the accounting equation, known balances, and the “missing entry” method.
• Key techniques: bank reconciliation, trial balance reconstruction, and use of control accounts.

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7 Analysis & Interpretation of Financial Information

7.1 Key Ratios (Cambridge Appendix A)

Ratio	Formula	Interpretation
Current Ratio	Current assets ÷ Current liabilities	Liquidity – ability to meet short‑term obligations.
Quick (Acid‑test) Ratio	(Current assets – Inventory) ÷ Current liabilities	Liquidity excluding stock, which may be slow to convert to cash.
Gross Profit Ratio	Gross profit ÷ Net sales × 100 %	Profitability of core trading activity.
Net Profit Ratio	Net profit ÷ Net sales × 100 %	Overall profitability after all expenses.
Return on Capital Employed (ROCE)	Net profit ÷ (Capital + Long‑term loans) × 100 %	Efficiency of using long‑term financing.
Return on Assets (ROA)	Net profit ÷ Total assets × 100 %	How well assets generate profit.
Debtors Turnover	Net credit sales ÷ Average debtors	Speed of collecting receivables.
Creditors Turnover	Net credit purchases ÷ Average creditors	Speed of paying suppliers.

7.2 Inter‑firm Comparison

• Ratios enable comparison of performance between businesses of similar size/industry.
• Always consider differences in accounting policies, economic conditions and business models.

7.3 Limitations of Financial Statements

• Historical cost – does not reflect current market values.
• Non‑financial information (brand reputation, staff morale, etc.) is omitted.
• Subject to estimates (depreciation, provisions, inventory valuation).
• Only a snapshot at a point in time; trends require several periods.

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8 Accounting Principles & Policies (Cambridge Appendix B)

1. Accruals – record transactions when they occur, not when cash changes hands.
2. Going concern – assume the business will continue operating for the foreseeable future.
3. Consistency – apply the same accounting methods from period to period.
4. Prudence (Conservatism) – do not overstate assets or income; anticipate losses.
5. Matching – expenses are matched with the revenues they help generate.
6. Materiality – record only items that could influence decisions.
7. Neutrality – information should be free from bias.
8. Reliability – information must be verifiable and trustworthy.
9. Relevance – information must be useful for decision‑making.
10. Comparability – users should be able to compare financial data over time and across entities.