ECO_INDEX-14

UNIT 14 SELF-BALANCING SYSTEM

STRUCTURE INDEX

14.0 Objectives

            After studying. this unit you should be able to:

Ø  Name the ledgers commonly used in business and explain the types of accounts contained in each Ledger.

Ø  define self-balancing system.

Ø  describe how each ledger is self-balanced.

Ø  prepare various adjustment accounts.

Ø  Explain sectional balancing and prepare the total debtors and total creditors accounts.

14.1 Introduction

You have learnt that all business transactions are recorded first in journal or its sub-division and then posted into the concerned accounts in the ledger. A statement called Trial Balance is also prepared at the end of the accounting period primarily to check the arithmetical accuracy of the entries in the ledger, Normally the firms maintain one ledger for all the accounts involved. So long as the volume of transactions is small and the number of accounts is limited, this works fairly well. But, as the business expands and the number of accounts increases, especially those of the debtors and creditors, maintaining all accounts in a single ledger becomes impractical. The ledger becomes too bulky and location of errors involves more time. Hence many firms decide to introduce multiple ledger system whereby separate ledgers are kept for debtors and creditors and the entries are recorded in each ledger in such a way that a separate Trial Balance can be prepared for each ledger. This is called 'Self-balancing System'. Sometimes the firms, while maintaining more than one ledger, do not adopt the self-balancing system. In such a situation, though separate Trial balance cannot be prepared for each ledger but the arithmetical accuracy can be duly credited by preparing certain control accounts. This is called 'Sectional Balancing'. In this unit you will learn about both the self-balancing and the sectional balancing systems: You will also study how they help in locating the errors more quickly and ensure the accuracy of postings into different ledgers.

14.2 Sub-division of Ledger

For the purpose of self-balancing and sectional balancing the ledger is usually divided into three parts. They are:

1.      General Ledger: It contains all the real and nominal accounts as well as the personal accounts other than trade debtors and trade creditors. Thus accounts like furniture, machinery, goodwill, interest, salaries, capital, loan, salary outstanding etc. are maintained in this ledger.

2.      Debtors Ledger: This is also known as 'Sales Ledger' or 'Sold Ledger'. It contains the Accounts of trade debtors i.e., the customers to whom goods are sold on credit. The accounts of persons/firms who are not the buyers of goods from the business, are maintained in General Ledger.

3.  Creditors Ledger: This is also known as 'Purchase Ledger' or 'Bought Ledger'. It contains the accounts of trade creditors only i.e., persons or firms who have supplied goods on credit to the business. The accounts of persons/firms who are not suppliers of goods or raw-materials are maintained in the General Ledger.

In case the number of trade debtors and trade creditors is fairly large, Debtors Ledger and Creditors Ledger can be further subdivided. For this, any suitable criteria may be adopted, Normally, the firms sub-divide them on alphabetical basis, say, A to F, G to K, L to P, and Q to Z or on geographical basis, say, district-wise, state-wise or nation-wise. Look at Figure 14.1 for sub-division of ledger.

14.3 How Ledgers are made Self-balancing

When separate ledgers are maintained for trade debtors and trade creditors, the debit and credit aspects of certain transactions will not appear in the same ledger. For example, in case of credit sales, the credit aspect (Sales Account) will appear in General Ledger whereas the debit aspect (personal account of the debtor) will appear in Debtors Ledger. Take another example like cash discount allowed by a creditor. The credit aspect (Discount Received Account) yell be recorded in General Ledger whereas the debit aspect (personal account of the creditor) will appear in Creditors edger. Thus, no ledger is self-balancing and it is not possible to prepare a separate Trial Balance for each ledger, hence, in order to make each ledger self-balancing it is necessary that the corresponding debit and credit aspects are fully provided in each ledger. This is done by opening some additional accounts called 'Adjustment Accounts' in each ledger. The Adjustment Account helps in completing the double entry in each ledger and making it self-balancing. The Adjustment Accounts opened in various ledgers are:

1 General Ledger Adjustment Account (in Debtors Ledger): It is opened in Debtors Ledger to provide the corresponding debits and credits for all entries related to trade debtors which appear in the General Ledger. Examples of such entries are: credit sales, sales returns, discount allowed, cash received from debtors, bad debts, etc.

2 General Ledger Adjustment Account (in Creditors Ledger): It is opened, in Creditor Ledger to provide the corresponding debits and credits for all entrees related to trade creditors which appear in the General ledger. Examples of such entries are: credit purchases, purchases returns, discount received, cash paid to creditors, etc.

 3 Debtors Ledger Adjustment Account (in General Ledger): It is opened in the General Ledger to provide the corresponding debits and credits for entries related to trade debtors which appear in Debtors Ledger.

4 Creditors-Ledger Adjustment Account (in General Ledger): It is opened in the General Ledger to provide the corresponding debits and credits for entries related to trade creditors which appear in Creditors Ledger

Thus, tile accounts which appear in three ledgers are as follows:

14.3.1 _14.3.2 Self-balancing the Debtors Ledger

You know tlie Debtors Ledger contains tlie personal accounts of trade debtors only. The General Ledger Adjustment Account is inserted a1 the end in Debtors Ledger for purposes of making it self-balancing by providing the necessary corresponding cebids and credits for all entries related to trade debtors. Let us therefore identify fire the items which usually appear on the debit and the credit sides of a trade debtor. They are as follows:

A Trade Debtor's Account

For self-balancitig, all items appearing on the debit side of the personal accounts of' trade debtors should be recorded on tlie credit side of [lie General Ledger Adjustment Account in Debtors Ledger and those appearing on their credit side should be recorded on its debit side. For this purpose, we take only tlie totals of such items for the period as a whole and pass the necessary journal entries as follows:

1.   For total credit sales, cheques dishonoured and bills receivable dishonoured.

Sales Ledger Adjustment A/c                 Dr.

(in General Ledger)

To General Ledger Adjustments A/c

(in Debtors Ledger)

2.  For total cash and cheques received from debtors, sales returns, bills receivable received, discount allowed, other allowances and bad debts: '

General Ledge Adjustment A/c             Dr.

(in Debtors Ledger)

To Debtors Ledger Adjustment A/c

(in General Ledger)

After passing the above two journal entries, tlie General Ledger Adjustment Account in Debtors Leader will appear as given in Figure 14.2.

To total figures for various items can, be extracted from the concerned subsidiary books. For example, 'credit sales' can be taken from the Sales Book, cash received from debtors' from the Cash Book, and so on. If necessary, additional columns can be provided in the subsidiary books for the purpose. This is explained later in sub-section 14.4.

Look at Illustration 1 and see how general Ledger Adjustment Account in Debtors Ledger is Prepared.

Illustration 1

From the following particulars draw up a General Ledger Adjustment Account in the Debtors Ledger

You will notice that the General Ledger Adjustment Account in Debtors Ledger has the necessary corresponding debits and credits for all entries related to trade debtors. This makes it self-balancing and now a Trial Balance can be prepared separately for the Debtors Ledger.

A Trade Creditor's Account

For self-balancing, all items appearing on the debit side of the personal accounts of trade creditors should be recorded on the credit side of the General Ledger Adjustment in Creditors Ledger and those appearing on their credit side should be recorded on its debit side. For this purpose, taking the total figures of such items the following journal entries will be passed:

1. For total credit purchases, cheques dishonoured and the bills payable Dishonoured:

General Ledger Adjustment Account             Dr.

(in Creditors Ledger)

To Creditors Ledger adjustment A/c

(in General Ledger)

2 For total cash and cheques paid to creditors, purchases returns, bill payable Accepted, discount received, other allowances:

Creditors Ledger Adjustment A/c.                  Dr.

(in General Ledger)

'To General Ledger Adjustment A/c

(in Creditors Ledger)

After passing the above two journal entries the General Ledger Adjustment Account inCreditors Ledger will appear as given in Figure 14.3.

 The figures for various items can be extracted from the concerned subsidiary books. For example, credit purchases' can be taken from the Purchase Book, cash paid to creditors from Cash Book, and so on. Look at Illustration 2 and see how General Ledger Adjustment in Creditors Ledger is prepared.

Illustration 2

From the following information prepare the General Ledger Adjustment Account in Creditors Ledger.

You will notice that the General Ledger Adjustment Account in Creditors Ledger has the necessary compounding debits and credits for all the entries related to trade creditors, this makes it self-balancing and now a separate Trial Balance can be prepared also for the Creditors Ledger.

13.3.3 Self-balancing the General Ledger

You know the General Ledger contains all real and nominal accounts. in case of mast of the transactions recorded in General Ledger both the debit and credit aspects would appear in this ledger itself. Take for example, depreciation on machinery. This involves Depreciation. Account (a nominal account) and the Machinery Account (a real account), in the General Ledger and so both debit and credit aspects arc recorded in this ledger

Itself. But, in case of transactions which involve the personal accounts of trade debtor’s on trade creditors, the situation is different. One aspect of such transactions appears in the General' Ledger and the other in Debtors Ledger or Creditors Ledger. Hence, for self-balancing the General Ledger it becomes necessary to provide the corresponding debits and credits for all entries related to wade debtors and trade creditors. Pot this purpose, we open the Debtors Ledger Adjustment Account and the Creditors Ledger Adjustment Account in the General Ledger. In fact these two accounts will automatically, opened when journal entries are passed for opening the General Ledger Adjustment Accounts in the Debtors md the Creditors Ledgers as stated in sub-sections 14.3.1 and 14.3.2, Thus, the Debtors Ledger Adjustment Account and the Creditors ledger adjustment Account in General ledger will be just the reverse of the General Ledger adjustment Account in Debtors Ledger and the General Ledger Adjustment Account in the Creditors Ledger respectively. Let us now prepare these two accounts from the information given in 

Illustrations 1 and 2.

Now let us take a comprehensive illustration and prepare all Adjustment Accounts.

Illustration-3

Note:

1.      Discount Disallowed: Any account of discount to debtors, if disallowed letter, is dabbled to the concerned debtor's personal account. Hence, it has been shown on the dchit side of Debtors Ledger Adjustment Account In General ledger and the credit side of the General ledger Adjustment Account in Debtors ledger.
2.      Interest and Charges debited to: It is an amount charged debtors on account of late payment or some errors, it has also been shown on the debit side of debits Ledger Adjustment Accounts in General Ledger and the credit side of General Ledger Adjustment Accounts In debaters Adjustments Ledger.

14.4 Some Peculiar Points

Contra Balance: Normality the personal accounts of deb     tors show a debit Balance and the. Personal account of creditors A credit balance, Sometimes, a debtor account may show a credit Balance and a creditor’s account it debt balance. It usually happens on accounts of over-payments. In such a situation both the debit null tile credit balances are show separately in the Adjustment Accounts. For example, the total of debit balance of various debtors Is Rs. 60,000 and the total of credit balances Rs. 80. These will be shown in the respective Adjustment Accounts as follows:

If the creditor’s accounts also show both types of balances, they will appear in the concerned Adjustments Accounts separately.

Transfers: Sometimes goods are bought from the person who is also a customer to the business. In such a situation, his personal account will appear in both the Debtors Ledger and the Creditors Ledger. The settlement of such accounts is made by paying or receiving the net amount. Hence, it becomes necessary to transfer his account from the ledger where it shows a lower balance to the other where his account shows a higher balance. For example, Ganesh's personal account in Debtors Ledger shows a debit balance of Rs. 10,800 and his personal account in Creditors Ledger shows a credit balance of Rs. 1,000. In such a situation, the credit balance of Rs. 1,000 in Ganesh's Account will be transferred from Creditors Ledger to his account in Debtors Ledger. Such transfer should also be recorded in the Adjustment Accounts. Whether the transfer takes place from creditors Ledger to Debtors Ledger or from Debtors Ledger to Creditors Ledger, it shall be reflected in various Adjustment Accounts as follows:

In Debtors Ledger Adjustment Account                                             Credit side

In Creditors Ledger Adjustment Account                                           Credit side

In General Ledger Adjustment Account in Debtors Ledger                Debit side 

In General Ledger Adjustment Account in Creditors Ledger              Credit side

Provision for Bad Debts: Sometimes you may find an item of provision for bad debts in the information from which the Adjustment Accounts are to be prepared. You know that this provision does not appear anywhere in the personal accounts of debtors. Hence it will not be included in the Adjustment Accounts. You may silently ignore it. The same thing is true of items like cash sales, bills discounted, 014 bad debts recovered, etc.

Look at illustration 4 and see how the above items have been treated.

Illustration 4

From the following details prepare General Ledger Adjustment Accounts and the Debtors Ledger and Creditors Ledger Adjustment Accounts as on 31 December 1988:

Illustration 5

From the following information prepare Debtors Ledger Adjustment Account in General Ledger.

Rs. 500. is to be transferred from Debtors Ledger to Creditors Ledger. Similarly, Rs. 600 is to be transferred from creditors Ledger to Debtors Ledger..

Debtors' Ledger Adjustment Account
 (in General Ledger)

Notes: Provision for Bad Debt, Bad Debts Recovered and Bills Receivable Discounted do not nipper in the personal accounts of Debtors. Hence no entry need be made in the Adjustment accounts.

14.5 Advantages of Self-Balancing System

            The main advantages of self-balancing system are as follows:

1-      It is easy to locate the errors because we prepare separate Trial Balance for each ledger. If the Trial Balance of a particular ledger agrees, it implies that there are no errors in that. Ledger. The detection work is confined only to the accounts in a ledger whose Trial .Balance does not agree. For-instance, if an error is committed in the personal account of a customer neither the General Ledger nor the Creditors Ledger is affected. It is only the Debtors Ledger which is affected and its Trial Balance will not agree. Hence you will look for the errors in Debtors Ledger only... Similarly, if the Trial Balance of General Ledger does not agree you will check entries in the nominal and real accounts only. This narrows down the area of detection work and the errors can be quickly detected:

2-      The maintenance of ledgers can be divided amongst many persons. This helps in quick posting and fixation of responsibility in case of errors and frauds.

3-      The main ledger becomes less bulky because the personal accounts of customers and suppliers are excluded. The system is very useful when the number of customers and suppliers is Ledger.

4-      It is easy to check the accuracy of each ledger independently with the help of Adjustment Accounts.

5-      It facilitates the preparation of interim accounts whenever required by includible the figure of total debtors and total creditors. There is no need to go through the Debtors and. Creditors Ledgers.

14.6 Sectional Balancing

The sectional balancing refers to a system under which only a section of the group of ledgers is self-balanced. If a firm which uses three ledgers viz., Debtors Ledger, Creditors Ledger and General Ledger, makes only one ledger self-balancing (normally the General Ledger) it will be called 'Sectional Balancing System'. Under this system only two Adjustment Accounts viz., Debtors Ledger Adjustment Account and Creditors Ledger Adjustment Account are prepared. They are termed as Total Debtors Account and Total Creditors Account respectively. They are also known as control accounts.

Most of the firms do not follow the self-balancing system. They simply prepare the Total Debtors and Total Creditors Account to check the accuracy of Debtors and Creditors Ledgers. These two accounts do not, in fact, form part of any ledger. Hence, no journal entries are passed for opening the accounts. They are prepared by extracting relevant 'figures from various subsidiary books. Like Debtors Ledger Adjustment Account, the Total

Debtors Account includes the total amounts of all those items which have beer, debited or credited to the personal accounts of the wade debtors. Similarly, the Total radiators Account, like the Creditors Ledger Adjustment Account, includes the total amounts of ill those items which have been debited or credited to the personal accounts of the trade creditors. Look at Figures 14.4 and 14.5 and note the sources of various items to be debited and credited in these control accounts.

 Look at illustration 6 and see how Total Debtors and 'Total creditors Accounts the prepared.

Illustration 6

The following figures are extracted from the books of a company for the year ended March 3 1, 1988: Opening Balance as per Debtors Ledger was Ks. 70,420 and as per 'Creditors Ledger Rs. 5 1,360. Transactions during the year ending March 3 1, 1988 were as follows:

Additional information:

I.            Account of Rs. 1,945 standing to the credit of a Supplier's Account was set off against an account for goods sold to that supplier.

II.            A balance of Rs. 450 outstanding from a debtor was adjusted against a claim from him for third party liability arising from accident.

III.            As on March 3 1, 1988 the balance as per Debtors and Creditors ledger amounted to Rs. 60,650 and 60,130 respectively.

You are required to prepare the Total Accounts to prove the accuracy of entries in the Debtors and Creditors Ledger.

14.7 Ruling of Subsidiary Books

You have learnt that for the preparation of Adjustment Accounts or Control Accounts you have to extract relevant figures from various subsidiary books. For this purpose some adjustment in the rulings of subsidiary books becomes necessary. For example, .if there is only one Debtors' Ledger and one Creditors Ledger you may add one, extra column on the debit side of the Cash Book to record receipts from trade debtors and another column on the credit side to record payments to trade creditors. These columns will readily provide the figures of total amounts received from trade debtors and total payments to trade creditors at the end of the accounting period. NO change will, however, be required in other subsidiary books. But if there are several Debtors and Creditors Ledgers maintained on alphabetical or regional basis, many additional columns will have to be provided in almost all the subsidiary books. These additional columns will analyse all transactions to provide the total Figures for each Debtors Ledger and each Creditors Ledger separately. Look at figure 14.6 and study how rulings in Sales Book will be arranged to provide the relevant periodic totals.

Figure 14.6

14.8 Let Us Sum Up

It is a common practice with firms having a large number of customers and supplier to adopt multiple ledger system. Under this system the ledger is usually divided in General Ledger, Debtors Ledgers and Creditors Ledger,'

When ledgers are maintained in such a way that a separate Trial Balance can be prepared for each ledger, it is called self-balancing system. Under this system each ledger contains certain Adjustment Accounts to provide the corresponding debits and credits. These accounts are opened through proper journal entries.

Most of the firm’s do not follow self-balancing system. They sub-divide the ledger but do not prepare separate Trial Balance for each ledger. However, in order to check the accuracy of Debtors and Creditors ledger they simply prepare two control accounts known as Total Debtors Account and Total Creditors Account. This system is known as sectional balancing and it is equally helpful in preparing the interim final acc6unts as and when required.

14.9 Key Words

Adjustment Account: An account which helps to complete the double entry in each ledger and make it self-balancing. '

Creditors Ledger: A ledger containing the personal accounts of all trade creditors.

Debtors Ledger: An I edger containing the personal accounts of all trade debtors.

General Ledger: A ledger containing all accounts other than the personal accounts of ' trade debtors and trade creditors. .

 Multiple Ledger System:’ A system of maintaining more than one ledger.

Sectional-Balancing System: A system of checking the accuracy of Debtors and Creditors Ledgers by paring the Total Debtors and Total Creditors Accounts.

Self-Balancing System: A system whereby each ledger can be self-balanced i.e... a separate Trial Balance can be prepared for each ledger.

Total Creditors Account: An account reflecting the total debits and credits for all entries related to trade creditors.

Transfers: Transfer of the lower balance in a particular personal account in one ledger to his personal account showing a higher balance in another ledger.

14.12 Terminal Questions/Exercises

Question
1 What do you understand by Self-Balancing System? Stets its advantages.

2 Explain briefly flow Debtors Ledger is made Self-balancing, T3uw do you deal with a transfer entry from one personal ledger to another?

3 What are Adjustment Accounts? Give journal entries necessary for self-balancing the General Ledger.
4 What is Sectional Balancing? How does it differ from Self-balancing? Give profoma the Total Debtors Account.

Exercises
1 - A firm has three ledgers in use viz Debtors Ledger, Creditors Ledger, and General Ledger. They are all kept on the self-balancing system. From tile following. Transactions prepare the necessary Adjustment Accounts as they would appear in each Self - Balancing System of the ledgers.