Chapter 3 — Subsidiary Books

In a small business one journal is enough. Ten or fifteen entries a day can be written by one person, posted to the ledger the same evening and balanced at month end. But consider a wholesale cloth merchant in Hyderabad who buys from twenty mills and sells to three hundred retailers across Telangana. On a single day there may be dozens of credit sales, several credit purchases, cash receipts from many customers, cash payments to suppliers and staff, goods returned by customers and goods sent back to mills. Recording all of these in one journal has three difficulties. First, a single book can be handled by only one clerk at a time, so the work cannot be shared. Second, the same kind of entry, such as Customer A/c Dr To Sales A/c, is written hundreds of times, which is wasteful. Third, every one of those entries has to be posted individually to sales account, making that account run into hundreds of lines.

The solution adopted by every large business is to sub-divide the journal. Instead of one journal, the business keeps several special journals, each reserved for one class of transaction that recurs frequently. These special journals are called subsidiary books, and also books of original entry or day books, because transactions are recorded in them first, day by day, before being posted to the ledger. The sub-division is not a departure from double entry; it is simply a practical way of applying it. Every transaction still ends up with a debit and a credit in the ledger.

The idea rests on the observation that most transactions fall into a small number of repetitive types: buying goods on credit, selling goods on credit, returning goods, receiving goods back, receiving and paying cash, and dealing in bills of exchange. Each of these gets its own book. The few transactions that do not fit any of these types, such as buying furniture on credit, writing off bad debts, charging depreciation or correcting an error, still go into an ordinary journal, which is now called the journal proper.

The eight subsidiary books ordinarily kept are:

• Purchases book (or purchases day book, or bought book), for credit purchases of goods.
• Sales book (or sales day book), for credit sales of goods.
• Purchase returns book (or returns outward book), for goods returned to suppliers.
• Sales returns book (or returns inward book), for goods returned by customers.
• Bills receivable book, for bills of exchange received from debtors.
• Bills payable book, for bills of exchange accepted in favour of creditors.
• Cash book, for all receipts and payments of cash and bank.
• Journal proper, for everything else.

The number of books a firm keeps depends on its size and nature; a firm that never deals in bills need not keep bills books. But the first four, the cash book and the journal proper are found in almost every trading business. The rest of this chapter takes each book in turn.

Sub-dividing the journal is worth the extra books because of the advantages it brings, and examiners regularly ask for them.

• Division of labour. Each book can be handled by a different clerk at the same time. One clerk writes the sales book, another the purchases book and a third the cash book, so a large volume of work is completed quickly.
• Specialisation and efficiency. A clerk who deals only with one book becomes expert in it, works faster and makes fewer mistakes.
• Saving of time and labour in recording. The name of the account credited (sales) or debited (purchases) is not written against each entry, because every entry in the book is of the same kind. Only the date, the party's name, the invoice number and the amount are needed. Narrations are dispensed with.
• Saving of time in posting. Instead of posting each transaction to sales account or purchases account, the book is totalled at the end of the month and only the total is posted. Sales account receives one entry a month instead of hundreds.
• Ready information. The sales book gives total credit sales, the purchases book total credit purchases and the returns books total returns, at a glance, without any analysis of the ledger.
• Easier location of errors. Because each book contains only one type of transaction, an error is confined to that book and its related accounts, and can be traced more quickly.
• Internal check. When the work is divided, the entries of one clerk are automatically checked against those of another. The cash book kept by the cashier is checked against the customers' accounts posted by the ledger clerk. Fraud becomes more difficult.
• Fixing of responsibility. If a mistake is found in the purchases book, the clerk in charge of that book is responsible; responsibility cannot be evaded.
• Flexibility. A business may keep only those books it needs and may add columns to a book, for instance a separate column for each department in the sales book, to obtain more detailed information.
• Reduced size of the ledger. Nominal accounts like sales and purchases carry only monthly totals, so the ledger is smaller and easier to handle.

Set against these advantages are a few limitations. Several books need more clerks and are more expensive than one journal, so the system is uneconomical for a very small firm. Cross-checking becomes necessary where entries in one book depend on another, such as the bills books and the cash book. And an error in the total of a book, once posted, affects the ledger account with a large single figure rather than a small one. On balance, for any business with a regular flow of credit transactions, the subsidiary book system is clearly the better one, which is why it is universal in practice.

One further point should be noted: subsidiary books are still books of original entry. They replace the journal for the transactions they cover; they do not replace the ledger. Every subsidiary book must be posted, either entry by entry or in total, and the accounting equation must still balance.

The whole system of subsidiary books depends on sorting each transaction correctly, and the first sorting question is always: is this a cash transaction or a credit transaction? The second question is: does it involve goods, or something else?

Cash transactions are those in which cash, or a cheque, changes hands at once. Every cash transaction, whatever it is for, goes into the cash book and nowhere else. Goods bought for cash, goods sold for cash, salaries paid, rent paid, cash received from a debtor, a cheque issued to a creditor, a machine purchased for cash: all of these are entered in the cash book. They never go into the purchases book, the sales book or the journal proper.

Credit transactions are those in which payment is deferred. They are sorted further by what is bought or sold:

• Goods bought on credit go into the purchases book.
• Goods sold on credit go into the sales book.
• Goods returned to a supplier go into the purchase returns book.
• Goods returned by a customer go into the sales returns book.
• Assets bought on credit, assets sold on credit, and all other non-cash, non-goods transactions go into the journal proper.

The word goods here means the articles in which the business regularly deals, bought for resale. A furniture shop buying tables on credit records them in the purchases book; a school buying the same tables on credit records them in the journal proper as an asset. A firm selling its old delivery van on credit does not use the sales book; the van is not goods. This distinction is tested constantly.

Bills of exchange are handled separately. When a customer accepts a bill drawn on him, it is recorded in the bills receivable book; when the business accepts a bill drawn by a supplier, it is recorded in the bills payable book. Cash actually received or paid on the maturity of a bill goes through the cash book.

How to recognise a credit transaction in a question. If a transaction names a person or firm and does not mention cash, cheque or bank, it is a credit transaction. Bought goods from Ramesh Rs 5,000 is a credit purchase. Bought goods from Ramesh for cash Rs 5,000 is a cash purchase and goes in the cash book with no reference to Ramesh's account. Purchased goods Rs 5,000, with no name and no mention of cash, is treated as a cash purchase in most questions, since there is no party to whom credit could be given.

Entries in the four goods books are not made from memory. Each rests on a document that passes between the buyer and the seller. Three documents matter.

Invoice (or bill). When goods are sold on credit, the seller prepares an invoice and sends it with the goods, keeping a copy. The invoice shows the seller's name and address, the invoice number and date, the buyer's name and address, the description of the goods, quantity, rate, gross amount, trade discount deducted, taxes added and the net amount payable, together with the terms of payment. For the seller, the copy of the outward invoice is the source of an entry in the sales book. For the buyer, the inward invoice received is the source of an entry in the purchases book. The same document therefore generates a sales entry in one set of books and a purchases entry in another. Invoices are numbered serially and filed, and the number is recorded in the book so that the entry can be traced.

Debit note. When a buyer returns goods to the seller, whether because they are damaged, defective, not as ordered or in excess, he prepares a debit note and sends it to the seller. It states that the seller's account has been debited in the buyer's books with the value of the goods returned, and gives the reason. A debit note is also sent when the buyer discovers that the invoice overcharged him. For the buyer, the debit note is the source of an entry in the purchase returns book. Debit notes are usually printed in red or marked clearly so that they are not mistaken for invoices.

Credit note. When the seller receives goods back from a customer, or agrees to an allowance for damaged goods or an overcharge, he prepares a credit note and sends it to the customer. It states that the customer's account has been credited in the seller's books with the amount. For the seller, the credit note is the source of an entry in the sales returns book. When the customer receives the credit note it confirms the debit note he sent earlier.

To keep the direction straight: the person who sends a debit note is saying, I have debited you; the person who sends a credit note is saying, I have credited you. Goods return outward produces a debit note from the returner and a credit note from the receiver.

A student should also know that for cash transactions the corresponding documents are the cash memo (for a cash sale or purchase) and the receipt (for cash received), which support the cash book. The invoice is the credit-sale equivalent of the cash memo.

The purchases book, also called the purchases day book, the bought book or the invoice book, records all credit purchases of goods, that is, goods bought for resale on credit. It records nothing else. Cash purchases of goods go to the cash book; credit purchases of assets such as machinery, furniture or stationery go to the journal proper. The source document is the inward invoice received from the supplier.

Ruling of the purchases book

• Date: the date of the invoice or of receipt of the goods.
• Particulars: the name of the supplier, and beneath it the quantity, description and rate of the goods. If trade discount is allowed, it is shown as a deduction here.
• Invoice number: the number of the supplier's invoice, for reference.
• L.F.: the ledger page of the supplier's account, filled in at the time of posting.
• Details: a working column for the gross amount and trade discount of each invoice.
• Amount: the net amount payable to the supplier, after trade discount.

The book is totalled at the end of the month (or week, in a large firm). Trade discount is deducted before the amount is entered, and it never appears anywhere else; cash discount, which arises only at the time of payment, does not appear in this book at all.

Posting the purchases book

• Each individual entry is posted to the credit side of the supplier's personal account in the ledger, with the words By Purchases A/c, because the supplier has given goods and is now a creditor.
• The monthly total is posted to the debit side of the purchases account with the words To Sundries as per purchases book, or simply To Sundries, because goods (an expense of trading) have come in.

Thus the double entry is completed: the credits to individual suppliers equal the one debit to purchases account. A supplier's name appears in the ledger once for each invoice; purchases account carries only one line per month.

When goods are purchased subject to GST, an additional column may be kept for input tax so that the tax paid is debited to a separate input GST account and only the value of goods is debited to purchases. This is beyond the introductory treatment but is mentioned because the book is easily extended with columns.

The sales book, also called the sales day book or sales journal, records all credit sales of goods. Like the purchases book it is confined to goods, the articles the firm regularly deals in. Cash sales go into the cash book, and the sale of an asset on credit, such as an old machine or vehicle, goes into the journal proper. The source document is the copy of the outward invoice sent to the customer.

Ruling of the sales book

The columns are the same as those of the purchases book, except that the particulars column carries the name of the customer and the invoice number is the firm's own outward invoice number, which runs serially. Trade discount allowed to the customer is deducted in the details column and only the net amount is carried to the amount column. The book is totalled at the end of the period.

Posting the sales book

• Each individual entry is posted to the debit side of the customer's personal account with the words To Sales A/c, because the customer has received goods and is now a debtor.
• The periodic total is posted to the credit side of the sales account with the words By Sundries as per sales book, because sales is an income.

The debits to individual customers together equal the single credit to sales account, so the double entry is complete.

Sales book versus sales account. Students sometimes confuse the two. The sales book is a subsidiary book, a book of original entry, in which each credit sale is written with the customer's name and invoice details; it is totalled but never balanced. The sales account is a ledger account, a nominal account, which receives the total of the sales book each month and also the cash sales posted from the cash book; it is a summary. Total sales for the year is the balance of the sales account, which equals the total of the sales book (credit sales) plus cash sales from the cash book.

Departmental sales book. A firm with several departments, say cloth, readymade garments and footwear, may rule extra amount columns, one for each department, so that the total sales of each department are known separately at the month end. This is an example of the flexibility of subsidiary books.

A sale on approval, where the customer may return the goods within a fixed time, is not entered in the sales book until the customer approves, because until then there is no sale. This is an application of the realisation concept.

Goods bought on credit are sometimes sent back to the supplier. They may have arrived damaged, be of the wrong quality or size, be more than was ordered, or have been delivered late and refused. Since the original purchase was recorded in the purchases book and the supplier was credited with the full invoice value, the return must be recorded so that the supplier's account is reduced and the cost of goods is corrected. This is done in the purchase returns book, also called the returns outward book because the goods go outward from the firm.

The book records only returns of goods bought on credit. If goods bought for cash are returned and the money is refunded, the refund goes through the cash book. If a supplier gives an allowance for a defect without the goods being physically returned, the allowance may also be entered in this book, since its effect on the supplier's account is the same.

The source document is the debit note that the firm prepares and sends to the supplier. Debit notes are numbered serially and the number is entered in the book.

Ruling of the purchase returns book

Note that the return is valued at the same net price at which the goods were bought. If trade discount was deducted on the purchase, the same rate of trade discount is deducted on the return, so that the supplier's account is reduced by exactly what was originally credited for those goods.

Posting the purchase returns book

• Each entry is posted to the debit side of the supplier's account with the words To Purchase Returns A/c, because the supplier has received goods back and the amount owed to him falls.
• The periodic total is posted to the credit side of the purchase returns account (returns outward account) with the words By Sundries as per purchase returns book.

The purchase returns account is a nominal account with a credit balance. At the year end it is closed by transfer to the trading account, where it is shown as a deduction from purchases, so that the trading account shows net purchases. Some firms credit returns directly to purchases account instead of keeping a separate returns account; keeping a separate account is better because it shows how much has been returned, which is useful information about the quality of suppliers.

The purchase returns book is generally the smallest of the goods books, and in a firm with very few returns the entries may instead be passed through the journal proper. But wherever returns are regular, the separate book saves work in the same way the purchases book does.

The mirror image of the purchase returns book is the sales returns book, also called the returns inward book, because goods come inward from customers. It records goods sold on credit that are sent back by customers, and allowances granted to customers for defective goods or overcharges. Returns by cash customers, where a refund is made, go through the cash book.

When a customer returns goods, the firm checks them, accepts the return and issues a credit note to the customer, informing him that his account has been credited. The credit note, numbered serially, is the source document for the sales returns book. Credit notes are often printed in red to distinguish them from invoices.

Ruling of the sales returns book

As with purchase returns, the goods are taken back at the net price at which they were sold, with the same trade discount deducted, so that the customer's account is reduced by exactly what was debited to him for those goods.

Posting the sales returns book

• Each entry is posted to the credit side of the customer's account with the words By Sales Returns A/c, because the customer has given the goods back and owes less.
• The periodic total is posted to the debit side of the sales returns account (returns inward account) with the words To Sundries as per sales returns book.

The sales returns account is a nominal account with a debit balance. At the year end it is transferred to the trading account and deducted from sales, so that the trading account shows net sales. A separate returns account is preferable to crediting sales directly, because the amount of returns is a measure of customer satisfaction and of the quality of goods dispatched.

The four goods books together. It is useful to see the pattern. Purchases book: suppliers credited, total debited to purchases. Purchase returns book: suppliers debited, total credited to purchase returns. Sales book: customers debited, total credited to sales. Sales returns book: customers credited, total debited to sales returns. In every case the individual party is posted with each entry and the nominal account receives one total, and in every case the returns book reverses the direction of the book it corrects. A student who has this pattern clear will never post a returns book to the wrong side.

The returns books are sometimes combined into a single returns book with two amount columns, one for returns inward and one for returns outward, when returns are infrequent. The posting rules do not change.

A credit sale creates a debt, and a debt is an informal promise. Sometimes the seller wants something more definite: a written, dated, unconditional order to pay a fixed sum on a fixed date. That is a bill of exchange. The seller (the drawer) draws the bill on the buyer (the drawee), who accepts it by signing across it, and the accepted bill becomes a negotiable instrument that the seller can hold until maturity, discount with a bank for immediate cash, or endorse to his own creditor. A promissory note, written by the debtor himself promising to pay, serves the same purpose.

From the point of view of the person who will receive the money, an accepted bill is a bill receivable. A firm that regularly takes bills from its customers keeps a bills receivable book in which every bill received is entered as soon as it is received. The book is both a subsidiary book and a register: it records the transaction for posting and it also keeps track of the due date and fate of each bill.

Ruling of the bills receivable book

The due date is the date of the bill plus the term plus three days of grace, which the law allows. A bill dated 6 June for two months falls due on 6 August, and with three days of grace on 9 August. If the due date is a public holiday, the bill is payable on the preceding working day.

Posting the bills receivable book

• Each entry is posted to the credit side of the account of the person from whom the bill is received (the debtor), with the words By Bills Receivable A/c, because he has given a bill in place of his debt.
• The periodic total is posted to the debit side of the bills receivable account, with the words To Sundries as per bills receivable book. Bills receivable account is a real account, an asset.

What happens to the bill afterwards, its payment on the due date, its discounting with a bank, its endorsement to a creditor, or its dishonour, is not recorded in the bills receivable book. Those events go through the cash book or the journal proper, and only a note is made in the how disposed of column. The book therefore records receipt only, but its columns let the firm see at a glance which bills are due when, which is why it doubles as a register.

In the accounts, the bill converts an ordinary debtor's balance into a bill receivable. The customer's account is credited and closed (or reduced), and the asset now appears under bills receivable. The total of bills still on hand at the year end is shown in the balance sheet as a current asset.

The bills payable book is the counterpart of the bills receivable book, kept by the party who has to pay. When a supplier draws a bill on the firm for goods sold on credit, and the firm accepts it, or when the firm writes a promissory note in favour of a supplier, the firm has created a bill payable: a definite liability to pay a fixed sum on a fixed date. Every such bill accepted is entered in the bills payable book on the date of acceptance.

Ruling of the bills payable book

The columns record who drew the bill, to whom payment is to be made (the payee, who may be the drawer or someone to whom he endorses the bill), the term, the due date including days of grace, and the place of payment. As with bills receivable, the book is a register as well as a journal: it tells the firm exactly how much it must have ready on each due date, which is essential for managing cash.

Posting the bills payable book

• Each entry is posted to the debit side of the account of the person to whom the bill is given (the creditor), with the words To Bills Payable A/c, because the creditor has received the firm's acceptance in place of the open debt and his account is reduced.
• The periodic total is posted to the credit side of the bills payable account, with the words By Sundries as per bills payable book. Bills payable account is a personal (representative) account with a credit balance, a liability.

Payment of the bill on maturity is recorded in the cash book (bills payable account debited, bank credited), and only a note is made in the how disposed of column. If the firm cannot pay on the due date, the bill is dishonoured and the liability reverts to the creditor's account through an entry in the journal proper.

Bills receivable and bills payable side by side

A single bill is therefore recorded in two different books in two different firms: the drawer enters it in his bills receivable book and the acceptor in his bills payable book. Bills of exchange are a large topic with their own chapter later; here the student needs only to know what the two books record and how they are posted.

The cash book records all transactions involving the receipt or payment of cash, and, in its common two-column form, all receipts into and payments out of the bank as well. Because cash transactions are the most numerous of all, the cash book is the busiest subsidiary book and is kept by a separate person, the cashier. A full chapter is devoted to it later; here the aim is to place it correctly within the system.

The cash book has a special character that no other subsidiary book has: it is both a book of original entry and a ledger account. It is a subsidiary book because cash transactions are recorded in it first, from receipts, cash memos and vouchers, in date order. It is also a ledger account because it is ruled like a ledger account, with a debit side for receipts and a credit side for payments, and it is balanced like one. The balance of the cash book is the cash in hand. For this reason no separate cash account is opened in the ledger when a cash book is kept; the cash book is the cash account. The same is true of the bank column, which serves as the bank account.

Ruling of a simple cash book

Posting the cash book. Because the cash book is itself the cash account, only the other side of each transaction needs to be posted. Every entry on the receipts (debit) side is posted to the credit side of the account named, and every entry on the payments (credit) side is posted to the debit side of the account named. Cash received from Raju is posted By Cash on the credit of Raju's account; rent paid is posted To Cash on the debit of rent account.

Kinds of cash book. The single column cash book records cash only. The double column cash book has cash and bank columns on each side, or in an older form cash and discount columns. The triple column cash book has cash, bank and discount columns. The petty cash book is a separate small book for minor expenses. All are dealt with in the cash book chapter.

Place in the system. Every transaction that involves cash or bank goes through the cash book and nowhere else. This includes cash purchases and cash sales (never in the purchases or sales books), payment of expenses, receipt of incomes, money received from debtors and paid to creditors, money paid for assets, and receipts and payments on bills. The one rule to remember is: if money moved, it is in the cash book.

When the journal has been sub-divided, the seven special books take over the recording of purchases, sales, returns, bills and cash. What is left is a small number of transactions that occur only occasionally and do not fit any special book. For these the firm keeps the original journal, now called the journal proper or the general journal. It is ruled exactly like the journal of the previous chapter, with date, particulars, L.F., debit and credit columns, and every entry carries a narration.

The transactions that go into the journal proper fall into recognisable groups:

• Opening entries. The entry at the start of the year bringing forward assets, liabilities and capital.
• Closing entries. Entries at the year end transferring the balances of nominal accounts to the trading account and the profit and loss account, and transferring net profit to capital.
• Adjusting entries. Entries at the year end for outstanding expenses, prepaid expenses, accrued income, income received in advance, depreciation, provision for doubtful debts and closing stock.
• Transfer entries. Entries moving an amount from one account to another, such as transferring drawings to capital or interest on capital to capital.
• Rectifying entries. Entries that correct errors found in the books.
• Credit purchase and sale of assets. Buying machinery, furniture or a vehicle on credit, or selling an old asset on credit. These are not goods and so cannot enter the purchases or sales book.
• Miscellaneous entries. Bad debts written off, goods withdrawn by the proprietor, goods given as charity or as free samples, goods lost by fire or theft, dishonour of a bill or a cheque, endorsement of a bill, interest on capital or drawings, and any other transaction with no cash and no goods.

Posting the journal proper. Every entry is posted individually to the two (or more) accounts it names, on the debit side of the account debited and the credit side of the account credited, exactly as in the previous chapter. There are no totals to post, because the entries are of different kinds.

Examples of journal proper entries

The journal proper is the residual book, but it is not unimportant. The year-end entries that convert a trial balance into final accounts all pass through it, and the correction of errors, which decides whether the accounts are right, is done in it. A firm with subsidiary books cannot do without it, and a student must be able to say at once, for any transaction, whether it belongs in a special book or in the journal proper.

The individual books have now been described. What remains is to see them together, because the pattern of posting is what an examination tests, and because seeing all the rules in one table makes them easy to remember.

Three ways of remembering the pattern

• The party named in an entry is always posted individually, and on the side the golden rule of personal accounts dictates: a supplier who gives goods is credited; a customer who receives goods is debited; a party who takes goods back or gives a bill is posted the opposite way.
• The nominal or real account that the book is named after receives only the total, on the side that the nature of the account dictates: purchases (expense) debit; sales (income) credit; purchase returns (reduction of expense) credit; sales returns (reduction of income) debit; bills receivable (asset) debit; bills payable (liability) credit.
• The cash book is the exception: it needs no total posting because it is itself the ledger account for cash and bank.

Why the double entry still balances. In each goods book and bills book, the sum of the individual postings to personal accounts equals the total posted to the summary account, and they are on opposite sides. In the cash book, each entry has one posting to the opposite side of another account, and the cash book itself is the other half. In the journal proper each entry carries its own debit and credit. Therefore, when all the books have been posted, total debits in the ledger equal total credits, and a trial balance can be drawn.

Frequency of posting. Personal accounts are posted daily or as entries are made, so that a customer's or supplier's balance is always current. Totals are posted at the end of the week or month. The L.F. column of each book records where each entry went, and an unfilled L.F. column shows what remains to be posted. This discipline is what makes the system reliable, and it is what a student should reproduce when asked to prepare a subsidiary book and post it.