Accounting Records
Category ListsAn accounting system needs to have a category list, which serves as a database skeleton to identify the various report categories tracked by the system.
A category list includes both balance sheet(What's Left?)classifications such as cash, property and equipment, accounts payable.
This list also includes income and expense (What Happened?) accounts such as sales revenue, rent expense and so on.
A customized accounting system begins with the design of a chart of accounts for the business. The designer needs to show separately the meaningful economic activities of the accounting entity.
Chart of Accounts
A chart of accounts is the index to the general ledger. It shows the various categories of assets, liabilities, income, and expenses that comprise the classification matrix of the accounting system.
A detailed and accurate chart of accounts is essential, since all financial reports must rely on the distinctions shown in the Chart of Accounts. For example, if your business wanted to know how much sales were in X Widgets, as compared with Z Bunny Dolls, you would need a separate sales account for X Widgets and Z Bunny Dolls to produce Profit and Loss Statement showing each type of sales separately.
Copies of the chart of accounts should be provided to the officers and directors including the treasurer (in charge of writing checks), deposit manager (in charge of deposit activity), and controller (in charge of bank reconciliation's and accounting records).
Accounting Journals
Chronological diaries of accounting transactions are called journals.
Detailed journals include sales journals, purchases, cash received, cash spent, payroll activity, and general.
General journals are used to record transactions that don't fit into a specific sub-category, and accounting adjustments to fix errors.
General Ledger
General Ledger -- Transactions Sorted by Categories -- the Running Total Register.
The general ledger is a detailed record of various transactions sorted into Chart of Account categories (sorted by pigeonholes).
After the transactions have been entered into one of the chronological journals, they need to be reviewed or edited. This is an essential accounting procedure to avoid mistakes!
Then the transactions are entered ("posted") into the general ledger.
"Running totals" of income and expense account activity are accumulated by predetermined classifications in the general ledger.
The general ledger is also where the balance sheet or (What's Left) amounts are calculated. If the total of all the accounts in a general ledger is zero; the general ledger is then "in balance".
Trial Balance
Trial Balance -- the Account Balance Snapshot
The numbers in a trial balance are the balances for asset and liability accounts and the running totals of the income and expense accounts for the current fiscal year.
When manual accounting records were common, the trial balance was the report that was prepared to show that the books were in balance, that is that the total of the accounts added up to zero!
Entering Transactions
Double Entry Accounting RulesBasic Rules for Recording Transactions
There are a few basic rules for entering transactions in a double entry system. The arithmetic sum of any transaction or group of transactions has to sum to zero.
Each separate line in a transaction has to map to an existing account classification. If there is no classification for a given line in a transaction, the chart of accounts has to be modified to add the needed account.
You enter each part of a transaction as a separate amount. That is if you make a sale to a customer enter the entire amount of the sale to the sales account.
In order to keep a clear running total of sales, do not offset any costs of the sale against the sales amount. By entering the income and expense portion of a transaction separately, we are providing a more complete record of what really happened. This process will produce more accurate financial statements.
From an outside auditor's point of view, once a transaction has been entered, edited, and posted to the general ledger, it must not be erased or deleted.
If an error has been made it can be corrected by entering a new transaction. The reason for this is that if transactions could be entered and later modified, the so-called audit trail would be corrupted.
Audit Trail
What is an Audit Trial and Why Do We Need It?
An audit is a test of accounting records that is made some time after the accounting transactions have been entered. Auditors do not test every transaction in an accounting period ; they use samples and draw general conclusions from the samples.
To be sure that whatever sample selected represents a reliable pattern of business transactions, the auditor uses the recording and non-erasure rules built into the accounting system. This allows the auditor to track every transaction that has been posted into the system, including errors and corrections.
If audit trail rules are observed, the auditor can believe the patterns he or she may discover in the sampling process. The auditor can conclude, based on the samples, that the date of each transaction entered into the system is accurate, that established data entry and transaction authorization procedures have been followed, and there are no non-disclosed changes in previously recorded transactions.
For example, let's say a check was made out to the James River Skimming Company and the signature was forged by an employee of your business, who just happens to own the James River Skimming Company. Your computer controls require that the name of each check payee be recorded in the cash spending journal. But Joe Crook, who owns the James River Skimming Company, manages to alter the cash spending journal to show that the check was made out to Brewster Contractors, a regular vendor. If your accounting control system does not record that the payee name was changed from James River Skimming Company to Brewster Contractors, the audit trail has been lost.
If a clear audit trail is not maintained the records may not be auditable, either by management or outside accountants.
How Often Do You Enter Transactions?
How often do you want to know What Happened and What's Left?
Most businesses record cash transactions on a daily basis, at least in the checkbook. If you are using a computer accounting system to write checks, you would then automatically be entering your computer cash transactions on the same daily basis.
The longer time between the occurrence of an accounting event and the recording of the event, the more likely errors will occur because no one checks the transactions on a timely basis, and errors will not be discovered.
Edit Transactions to Catch Errors
On a periodic basis, certainly as often as transactions are posted into the general ledger, the transaction journals should be edited (audited) for accuracy, plausibility and business purpose.
If possible, the person who performs the transaction audit should be a different person that the one who created the transaction.
This is done not because the ethics of the original bookkeeper are suspect, but because people who are engaged in detail accounting tend not to discover their errors as fast as a knowledgeable pair of outside eyes.
Post Transactions
After the transaction journals have been edited, they should be posted to the general ledger. In a computer based accounting system, this is as simple as a menu command.
Posting the transactions updates the running totals and balances and allows current financial reports to be printed.
Computer accounting systems often allow the user to post as soon as the transaction is entered. This provides for timely reports, but can also short circuit the transaction editing process. In these circumstances checking procedures are performed on the financial and accounting reports.
Depending on the nature of the audit trial controls, errors not caught until after posting may require adjusting journal entries to fix.
Checking Results
Finding Errors and Avoiding Mischief
In order for you (or anyone else) to check the results of a business' accounting procedures, you need a clearly understood set of rules for processing cash receipts, writing checks for expenditures, and establishing that transactions are properly entered in the books. There are two basic risks that a business owner has to deal with in making sure that the accounts are accurate.
First, that no one is stealing money from the business.
Second, that there are no large undiscovered errors that make the accounts inaccurate.
In order to achieve these goals accounting controls are set up. These controls are the methods and procedures used to safeguard the assets of the business and insure the accuracy and reliability of the accounting records. They include the following basic controls:
A system of authorization (budgeting) and reporting for all transactions and entries.
Separation of duties concerning record keeping and handling and custody of cash.
Physical control of assets.
Internal auditing.
Separation of Duties.
Separation of duties provides an important internal control over the assets and records in any organization. It is a particularly essential control for small organizations where a limited number of persons are directly involved with these functions. It is imperative that this principle be strictly observed.
Review the Trial Balance for Errors
Print the Trial Balance and Review for Errors
When you have printed the trial balance (assuming a computer based accounting system), you should then perform a series of test to establish the accuracy of the numbers.
These tests should include:
1. Making sure that the trial balance adds up to zero! (Double Entry Rule #1).
2. Checking to see that accounts that ordinarily have plus balances are not showing minus balances. For example, cash account balances should be plus. If they are minus, this may indicate that you have not entered all of your deposits into the accounting system, or more drastically, that you have overdrawn your bank account.
3. Checking to see whether there are unexpected changes in account balances from the previous month. An unexpected change may indicate that a transaction(s) may have been classified to the wrong account.
Reconcile Bank Accounts
Bank account reconciliation is the first test in proving accounting records.
A reconciliation explains the differences between the balance according to the monthly bank statements and the amount shown as the bank balance in the general ledger.
Differences may consist of checks written which have not cleared the bank, deposits recorded on the books that also have not cleared the bank, unrecorded bank service charges, and so on.
Proving Accounts Receivable
In your general ledger chart of accounts there is an account called "Trade Accounts Receivable".
This is the total amount that your customers owe you at the trial balance date. But if a detailed listing of customer accounts does not add up to the general ledger total, something is wrong!
Thus it is essential that someone checks to see that the total individual customer balances adds up to the amount shown as Trade Accounts Receivable in your trial balance.
You may say, I don't have to worry about that, the computer programs takes cares of the addition and subtraction. Not So! Computers are as capable of making errors as humans. And the reason that the detailed list of balances does not add up to the trial balance total may be that there has been an error in transferring customer transactions into the computer general ledger program.
Amounts due from customers at a financial statement date equaled the amount of total accounts receivable shown in the trial balance.
An essential monthly report is aged reporting by customer (current, over 30 days, over 60 days, over 90 days) showing how old the accounts receivable balances are. If you see unpaid customer balances getting older and older, you should follow up to see if:
1. The customer was dissatisfied with the shipment or sale.
2. The customer is in financial trouble and cannot pay on time.
3. The customer actually paid your invoice, but your accounting system does not show the payment.
This is a quick way to see If they get older and older, but are not collected, they may not be collectible.
Proving Accounts Payable
Proving accounts payable balances, although clerically similar to proving customer receivable, is not as essential a financial task, because these are amounts you owe vendors and you should know about your ability to pay on time. But this does not negate the need for the proving process.
The proof consists of checking that sum of the individual amounts due to vendors at a trial balance date equals the amount shown as "Trade Accounts Payable" in the general ledger.
You should also get an aged reporting by vendor of how old the accounts payable balances are. This could provide information about disputed invoices.
Accounting Adjustments
Adjust the records for Discovered Errors
To coin a phrase, "trial and error" is meaningful in this context. You should make correcting (adjusting) journal entries for any mistakes found in the review process.
Draft Financial Statements
Print and Issue the Financial Statements
Once the review and correction process is complete, then the financial statements can be printed and issued.
Management readers of the financial statements find any additional errors, such as a transaction such as a bank borrowing, that has not been recorded. If any errors are found, the review and correction process should be repeated.
In computer accounting programs where the books are posted at the time a transaction is entered, you get quick information, but you abandon the explicit process of reviewing transactions before creating general ledger entries.