INTRODUCTION TO ACCOUNTING SYSTEMS

The dual nature of transactions

Every transaction must be entered in two places or the equation would fail.

There is no exception to this rule. Every transaction that affects assets, liabilities, capital, income or expenses must have an offsetting effect to maintain the accounting equation. Every transaction must be recorded (entered) in two places.

The process of doing this is called double entry book-keeping.

The accounting equation is useful to give an overview of the accounting process but it is not very practical as a tool to account for the transactions of a business.

A business might enter into many thousands of transactions and it would be very time consuming to redraft the equation after each of them. A system is needed to allow large numbers of transactions to be recorded and then summarised to allow the production of financial statements on a periodic basis.

Book-keeping

Book-keeping is the process of recording financial transactions in the accounting records (the ‘books’) of an entity.

All transactions are analysed into different types and are then recorded in a series of individual records called accounts. There is a separate account for each different type of transaction, or that is to say, for each type of asset, liability, income, expense, and owners’ capital.

Accounts are kept together in a ledger. A ledger is a term meaning a collection of related accounts.

There are different types of ledgers in an accounting system but the accounts that record the double entries for each transaction are kept in the general ledger, (also known as the nominal ledger or the main ledger)

Overview of accounting

Illustration:

 

A trial balance can be extracted at any time but the rest of this book will assume it to be at the end of an accounting year.

Any adjustments made to the trial balance must also be reflected in the general ledger accounts. In other words, if something is added in after the trail balance is extracted it must also be added into the general ledger.

There is a large exercise to tidy up the general ledger once the year-end financial statements are produced. It involves clearing all of the income and expense accounts into a statement of comprehensive income account. The balance on this account is then transferred to equity. This is to prepare the general ledger for the next accounting period.