Control Accounts

1 Introduction

The last chapter – bank reconciliations – covered a method of checking the accuracy of the entry of transactions concerning cash in and out of the bank.

However, a great many of the transactions of a company involve purchases and sales on credit. It is important to have a way of checking these also. This chapter covers a way of checking them.

It is important that you revise, and are happy with, the earlier chapter on Books of Prime Entry. You will not be asked to write up these books, but, as you will see, it is very likely that you will be presented with errors that have been made in these books.

2 Control Accounts

YouTube videoLoad YouTube video

You will remember that in practice, the following occurs if we make a sale on credit:

1. the invoice is listed in the Sales Day Book (no double entry)

2. the amount of the invoice is taken from the Sales Day Book and entered in the account of the relevant customer in the Sales Ledger (not double entry)

3. at the month end, the total of the Sales Day Book is posted in the Nominal Ledger:

In a similar way, if cash is received from a customer:

1. the amount is listed in the Cash Receipts book (no double entry)

2. the amount of the receipt is taken from the Cash Receipts book and entered in the account of the relevant customer in the Sales Ledger (no double entry)

3. at the month end, the total of the Cash Receipts book is posted in the Nominal Ledger:

As a result, we end up with several ‘receivables’ accounts. We have an account for each individual customer in the Sales Ledger, and also a (total) Receivables account in the Nominal Ledger.

To avoid any confusion, we call the account in the Nominal Ledger the Total Receivables Account, or (more commonly) the Sales Ledger Control Account.

Because the sales ledger is also called the receivables ledger, the same account is also called the Receivables Ledger Control Account. In the same way the total payables account is called the Purchase Ledger Control Account or the Payables Ledger Control Account. Whichever name a question uses, it means the total account in the nominal ledger:

An obvious check that we can perform every month is to ask the bookkeeper in charge of the Sales Ledger to list all the individual balances and to total them up. This total should agree with the balance on the Sales Ledger Control Account. If the two figures do not agree, then there must be an error (or errors) that need to be corrected.

If the Sales Ledger Control Account contains errors, then our Financial Statements will be incorrect. If the Sales Ledger contains errors, then we risk chasing individual customers for the wrong amounts, or alternatively not chasing customers when we should be doing so!

This check will not discover all types of errors, but is a simple exercise to perform and will certainly detect many types of errors.

3 Returns, discounts, and contra entries

Before we look at examples of control accounts, there are three ‘special’ types of entry that we need to consider.

These entries may be necessary in any type of examination question, but are particularly common in control account questions.

3.1 Returns

Suppose we sell goods for $500 on credit to Mr X.

A week later, Mr X returns half the goods to us (and we accept the return).

Clearly, the return must be recorded in the individual account in the Sales Ledger, and the Sales Ledger Control Account in the Nominal Ledger.

Mr X’s account in the sales ledger is credited with $250, so he now owes $250. Returns are listed in a returns book (sales returns day book) and the total is posted in the nominal ledger:

For purchases the entry is reversed: goods returned to a supplier are debited to the Purchase Ledger Control Account and credited to purchase returns (returns outwards).

3.2 Discounts

A trade discount is a reduction in the list price given to a large or regular customer. It is simply deducted on the invoice — the sale is recorded at the net amount — so it never appears in the accounts. A cash discount (settlement discount) is offered to encourage the customer to pay quickly. When the goods are sold we do not know whether the customer will pay in time, so the sale is recorded at the full amount and the discount is recorded only when it is taken.

Suppose we sell goods for $1,000 on credit to Mr Y, and offer him a 5% discount if he pays the invoice within 1 month.

Mr Y does pay the account within 1 month and therefore pays us only $950.

Clearly, the discount must be recorded in the individual account in the Sales Ledger, and the Sales Ledger Control Account in the Nominal Ledger.

Mr Y’s account in the sales ledger is credited with the $950 received and with the $50 discount, which clears his balance. In the nominal ledger the discount is posted as follows; discounts allowed is an expense in the statement of profit or loss:

A discount received from a supplier for paying early is the reverse: Dr Purchase Ledger Control Account, Cr Discounts received (income). Current IFRS (IFRS 15) treats an expected prompt-payment discount as a reduction of revenue rather than an expense, but BA3 questions record it as discount allowed, as shown here.

3.3 Contra entries

Suppose we sell goods for $800 on credit to Mr Z.

Mr Z also happens to be a supplier, and we buy goods from him for $1,000 on credit.

We agree with Mr Z that instead of him paying us in full, and us paying him in full, we will simply pay to him the net amount owing of $200.

This bookkeeping entry to ‘cancel’ or ‘set-off’ the balances is known as a contra entry.

Clearly, the contra entry must be recorded in the individual account in the Sales Ledger, and the Sales Ledger Control Account in the Nominal Ledger.

After paying the net $200, Mr Z still appears to owe us $800 in the sales ledger, and we still appear to owe him $800 of the $1,000 in the purchase ledger. The contra cancels the two: Mr Z’s account in the sales ledger is credited with $800, his account in the purchase ledger is debited with $800, and in the nominal ledger:

A contra is always Dr Payables, Cr Receivables. No cash moves.

4 The Purchase Ledger Control Account

YouTube videoLoad YouTube video

Throughout this chapter so far, we have been using sales on credit to illustrate the use of Control Accounts.

However, exactly the same situation occurs with purchases on credit, and the balance on the Total Payables Account – or Purchase Ledger Control Account – should equal the total of the list of individual balances in the Purchase Ledger.

Returns, discounts and contra entries apply in exactly the same way as with the Sales Ledger Control Account.

The entries you will meet in the two control accounts are these:

Some items never go in a control account: cash sales and cash purchases (no receivable or payable is created), and an increase or decrease in the allowance for receivables, which is kept in its own account (Chapter 8). A refund to a customer is cash paid back — for example to a customer who paid too much or returned goods already paid for — so it is Cr Cash, Dr Sales Ledger Control Account. An overpaying customer can leave a credit balance in the sales ledger.

5 Control account reconciliations

YouTube videoLoad YouTube video

As we have already discussed, the balance on the Receivables Ledger Control Account should equal the total of the list of balances in the Receivables Ledger (and similarly the balance on the Payables Ledger Control Account should equal the total of the list of balances in the Payables Ledger).

If the two are not equal, then there must be an error - either in the Control Account, or in the list of balances. You can be asked questions in the exam requiring you to correct the errors.

For each error, decide which figure it affects:

A balance listed on the wrong side (a credit balance listed as a debit) is wrong by twice its amount. When every error has been corrected, the control account balance and the total of the list should agree; the corrected control account balance is the receivables (or payables) figure in the statement of financial position.

6 Control accounts and missing figures

Because a control account contains every credit transaction with customers (or suppliers), it can be used to find a figure that is missing — most often the credit sales or credit purchases of a business that does not keep full records. Enter everything that is known, including the closing balance, and the missing figure is the balancing amount.

7 Test your knowledge

Two quick checks before you move on: work through the flashcards to fix this chapter’s terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.