Understanding Business Accounting For Dummies, 2nd Edition (14 page)

Using the source document(s) for every transaction, the bookkeeper makes the first, or original, entry into a journal and then into the business's accounts. Only an official, established book of accounts should be used in recording transactions. A
journal
is a chronological record of transactions in the order in which they occur - like a very detailed personal diary. In contrast, an
account
is a separate record for each asset, each liability, and so on. One transaction affects two or more accounts. The journal entry records the whole transaction in one place; then each piece is recorded in the two or more accounts changed by the transaction.

Here's a simple example that illustrates recording of a transaction in a
journal
and then
posting
the changes caused by the transaction in the
accounts.
Expecting a big demand from its customers, a retail bookshop purchases, on credit, 50 copies of
Understanding Business Accounting For Dummies
from the publisher, John Wiley & Sons, Ltd. The books are received and placed on the shelves. (50 copies are a lot to put on the shelves, but our relatives promised to rush down and buy several copies each.) The bookshop now owns the books and also owes John Wiley £600.00, which is the cost of the 50 copies. You look only at recording the purchase of the books, not recording subsequent sales of the books and paying the bill to John Wiley.

The bookshop has established a specific stock or account called ‘Stock-Trade Paperbacks' for books like this. And the purchase liability to the publisher should be entered in the account ‘Creditor-Publishers'. So the journal entry for this purchase is recorded as follows:

Stock-Trade Paperbacks + £600.00Creditor-Publishers + £600.00

This pair of changes is first recorded in one journal entry. Then, sometime later, each change is
posted,
or recorded, in the separate accounts - one an asset and the other a liability.

Not so long ago, bookkeepers had to record these entries by hand, and even today there's nothing wrong with a good hand-entry (manual) bookkeeping system. But bookkeepers can now use computer programs that take over many of the tedious chores of bookkeeping. Computers have come to the rescue - of course, typing has replaced hand cramps with repetitive strain injury, but at least the work gets done more quickly and with fewer errors! (See Appendix B for more about popular accounting software packages for personal computers.)

We can't exaggerate the importance of entering transaction data correctly and in a timely manner. For example, an important reason that most retailers these days use cash registers that read bar-coded information on products is to more accurately capture the necessary information and to speed up the entry of this information.

4.
Perform end-of-period procedures - preliminary steps for preparing the accounting reports and financial statements at the end of every period.

A
period
can be any stretch of time - from one day to one month to one quarter (three months) to one year and is determined by the needs of the business. A year is usually the longest period of time that a business would wait to prepare its financial statements. As a matter of fact, most businesses need accounting reports and financial statements at the end of each quarter, and many need monthly financial statements.

Before the accounting reports can be prepared at the end of the period (see Figure 2-1), the bookkeeper needs to bring the accounts of the business up-to-date and complete the bookkeeping process. One step, for example, is recording the
depreciation expense
for the period (see Chapter 6 for more on depreciation). Another step is getting an actual count of the business's stock so that the stock records can be adjusted to account for shoplifting, employee theft, and so on.

The accountant needs to take the final step and check for errors in the business's accounts. Data entry clerks and bookkeepers may not fully understand the unusual nature of some business transactions and may have entered transactions incorrectly. One reason for establishing
internal controls
(discussed in ‘Protect the family jewels: Internal controls', later in this chapter) is to keep errors to an absolute minimum. Ideally, accounts should contain very few errors at the end of the period, but the accountant can't make any assumptions and should make a final check for any errors that fell through the cracks.

5.
Prepare the adjusted trial balance for the accountants.

After all the end-of-period procedures have been completed, the bookkeeper prepares a complete listing of all accounts, which is called the
adjusted trial balance.
Modest-sized businesses maintain hundreds of accounts for their various assets, liabilities, owners' equity, revenue, and expenses. Larger businesses keep thousands of accounts, and very large businesses may keep more than 10,000 accounts. In contrast, external financial statements, tax returns, and internal accounting reports to managers contain a relatively small number of accounts. For example, a typical external balance sheet reports only 20 to 25 accounts, and a typical income tax return contains less than 100 accounts.

The accountant takes the adjusted trial balance and telescopes similar accounts into one summary amount that is reported in a financial report or tax return. For example, a business may keep hundreds of separate stock accounts, every one of which is listed in the adjusted trial balance. The accountant collapses all these accounts into one summary stock account that is presented in the external balance sheet of the business.

In short, the large number of specific accounts listed in the adjusted trial balance is condensed into a comparatively small number of accounts that are reported in financial statements and tax returns. In grouping the accounts, the accountant should comply with established financial reporting standards and income tax requirements.

6.
Close the books
- bring the bookkeeping for the fiscal year just ended to a close and get things ready to begin the bookkeeping process for the coming fiscal year.

Books
is the common term for
accounts
.
A business's transactions are a constant stream of activities that don't end tidily on the last day of the year, which can make preparing financial statements and tax returns challenging. The business has to draw a clear line of demarcation between activities for the year (the 12-month accounting period) ended and the year yet to come by
closing the books
for one year and starting with fresh books for the next year.

The business may have an
accounting manual
that spells out in great detail the specific accounts and procedures for recording transactions. But all businesses change over time, and they occasionally need to review their accounting system and make revisions. Companies do not take this task lightly; discontinuities in the accounting system can be major shocks and have to be carefully thought out. Nevertheless, bookkeeping and accounting systems can't remain static for very long. If these systems were never changed, bookkeepers would still be sitting on high stools making entries with quill pens and ink in leather-bound ledgers.

Managing the Bookkeeping and Accounting System

In our experience, far too many business managers either ignore their bookkeeping and accounting systems or take them for granted - unless something obvious goes wrong. The managers assume that if the books are in balance, then everything is OK. The section ‘Recording transactions using debits and credits', later in this chapter, covers just exactly what ‘the books being in balance' means - it does
not
necessarily mean that everything is OK.

To determine whether your bookkeeping system is up to scratch, check out the following sections, which, taken as a whole, provide a checklist of the most important elements of a good system.

Categorise your financial information: The chart of accounts

Suppose that you're the accountant for a company and you're faced with the daunting task of preparing the annual income tax return for the business. This demands that you report the following kinds of expenses (and this list contains just the minimum!):

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