The Accounting System

• This looks at the overview of the accounting system from the source documents that are
used initially to enter a transaction in the books of account.
• It looks at the books of original entry and provides an introduction to the double entry
system of book keeping and the ledgers.
• A summary of the procedures followed at the end of the accounting year to balance off the
accounts and prepare the trial balance.
• From the final trial balance the financial statements are prepared which show the results of
the year trading, be it profit or loss (income statement) together with the balance sheet that
shows the financial position of the organization at specific time.
• Businesses operate on a 12 month cycle normally from January to December from one year
to the other.
• During this 12 month cycle businesses receive many documents of financial nature that need
recording in the books of account.
• At the end of each month the books are balanced off and a trial balance prepared from
which the financial statements are prepared.
• At the end of each month, outstanding accounts are settled, wage and salaries paid, and
money received during the month recorded.
• The financial statements of a business are prepared on an annual basis since they are
required for taxation purposes and for use by the owners of the business.

Source Documents

• These are documents where original information is found. Examples include sales invoices,
purchase invoices, credit notes, receipts and debit notes.
• All the businesses and organizations involved in trading activities or providing a service use
these important documents.

Invoices

This is a document prepared by the seller when they sell goods or provide a service on credit. In the
sellers records the invoice is the sales invoice and in the purchaser’s records it is the purchase
invoice. Information contained on invoice include:

• Seller’s name and address

• Purchaser’s name and address
• Purchaser’s order number and date
• Date of delivery
• Description of goods and services supplied
• Quantity and price per item
• Total amount due
• Terms and conditions

Credit note

This is a document raised by the supplier of goods when goods have been returned by the purchaser
due to their being damaged, faulty or supplied to the wrong specification, or when an overcharge
has been made on an invoice. Once raised the amount owed by the customer will be reduced by the
amount of the credit note. Credit notes are important documents that need entering in the books of
both the supplier and the purchaser.

Debit note

This is raised when the supplier agrees that the goods bought previously may be returned. The debit
note is raised by the purchaser and sent to the supplier. Details of the goods returned and the
reason for the return are given. The debit note will show that the purchaser expects the seller to
bear the charge.

Paying in slips

These are slips used for paying money into the bank account.

Cheque counterfoil

Once a cheque is paid out the cheque counterfoil must be completed with details of the amount
paid and to whom together with the date. The payment is also recorded in the cashbook.

Receipt

This is an acknowledgement of receipt of money from a customer and is often issued when a
customer purchases goods or services for cash.

Petty cash voucher

This is a form used by anyone requesting payment for small item of expenditure incurred on behalf
of the business. The form gives details of the expense and should be authorized and duly signed. This
is recorded in the petty cash book.

The accounting system is as follows:

Collect financial information from business documents

Data is entered from the source documents into the books of original entry

Then the double entry system is used to post entries from books of original entry to the ledgers

The ledger accounts are balanced off and trial balance prepared to check that balances from ledger
accounts are correct

The trading profit and loss account is drawn up to determine the gross profit or loss
Then the balance sheet is prepared to show assets, liabilities and capital at the end of the accounting
period

Books of Original Entry

These books in which transactions are first entered. The books are as follow:

1. The Journal
This book records items that are much less common and sometimes complicated and are
not recorded in any other book of original entry.
2. Sales Day Book or Sales Journal
This is a book used for listing sales invoices. It gives details such as date of sale, to whom and
the amount of the sale. These are daily sales transactions.
3. Purchases Day Book or Purchases Journal
This records all the purchase invoices received from the suppliers of goods and services. All
the daily purchases are recorded in the purchase day book.
4. Purchases Returns Day Book or Returns Outward Day Book or Journal
This book records all goods returned to the suppliers
5. Sale Returns Day Book or Returns Inwards day Book or Journal
This book records all the goods returned by the customers. This will lead to a credit note
being issued to them.
6. Cash Book
This is a book of original entry used to enter all cash and bank receipts and payments. The
cash book records the business’s bank account and provides details of the amount of cash in
hand. The cash book is both the book of original entry and part of the double entry system
as it gives the balances of cash in hand and at bank.
7. Petty Cash Book
This is used for making payments for small or petty payments details of which are entered
from petty cash vouchers supported by a receipt.

The Double Entry System

• This is a method of recording business transactions in the books of accounts of a business.

• The double-entry system provides checks and balances to ensure that your books are always
in balance. Every transaction has two journal entries: a debit and a credit. Debits must
always equal credits. Because debits equal credits, double-entry accounting prevents some
common bookkeeping errors. Errors that aren't prevented are easier to find. You can
probably see why most accountants consider double-entry accounting the basis of a true
accounting system.
• With double-entry accounting, every transaction comprises at least one debit and one
credit. Usually, one of the accounts is a balance sheet account. Entries that are not made to
a balance sheet account are made to an income account or expense account. Income and
expenses affect the net income of the business, which ultimately affects your equity. Each
transaction (journal entry) is a real-life example of the accounting equation (assets =
liabilities + owner's equity).
 • These business transaction under the double entry system affects two things e.g if a
business buys goods valued at K500 and pays for them by cheque, two things will have
occurred:
1. The stock of goods is increased by K500
2. The money in the business bank account will decrease by K500

If the business then pays cash for a specific piece of equipment, then

1. The money in the cash account will decrease

2. The business will have acquired equipment

The dual aspect of treating each transaction is then recorded in an account. An account will show
the history of a particular transaction.

The Ledger Account

• In the double entry system, the accounts are kept in a ledger.

• Small businesses maintain one ledger account as only one member of staff records the
transactions.
• Big businesses maintain several ledger accounts as several members of staff record the
transactions at the same time.
• First, details are recorded from the source documents into the books of original entry.
• The next stage is to show the effect of the transactions by putting them into the double
entry accounts.
• The following are the different types of ledgers used:
a. Sales ledger (Debtor’s ledger)
This ledger shows records of the customer’s personal accounts
b. Purchases ledger (Creditor’s ledger
This ledger shows records of suppliers’ personal accounts
c. General ledger (Nominal ledger)
This ledger records the remaining double entry accounts, such as assets, capital,
expenses and income.

Classification of Accounts

The accounts are divided into personal accounts and impersonal accounts.

Personal accounts

These are accounts that deal with people and businesses i.e debtors and creditors. Debtors are
people owing money to the business and creditors are people or businesses to whom money is
owed. The debtors accounts are maintained in the sales ledger also referred to as debtors ledger and
the creditors accounts are maintained in the purchases ledger also referred to as creditors ledger.

Impersonal accounts

These are divided into real and nominal accounts.

Real accounts are those that deal with possessions of the business such as buildings, machinery,
computer equipment, fixtures and fittings, stock etc.

Nominal accounts are those in which expenses and income are recorded such as sales, purchases,
wages, electricity, commissions received etc.
The capital, drawings and other similar accounts are kept in a private ledger. This ensures privacy in
confidential matters.

Balancing off Accounts and the Trial Balance

At the end of each month businesses always balances off their accounts and prepare the trial
balance. The trial balance is prepared for several reasons such as:

1. To check periodically that the transactions have been entered correctly in the books of
accounts
2. To know how much money is outstanding and how much money is outstanding and how
much money the business owes
3. For easy preparation of the financial statements showing the financial performance and
financial position of the business at specific dates

Financial Statements

These are prepared at the end of each financial year after the trial balance has been prepared. The
financial statements include:

a. Trading Profit and Loss Account (Income Statement) showing gross profit and net profit or
losses made during the period.
b. Balance Sheet (Statement of Financial Position) showing the financial position at the end of
the financial year.

Documents Book of original entry

Sales Invoice Sales day book or sals journal
Credit notes (sent to customers) Sales returns day book or returns inward day
book
Purchases invoice Purchases day book or purchases journal
Credit notes received from suppliers Purchases returns day book or returns outward
day book
Cash and cheques received Cash book
Cheques paid out Cash book
Small cash payments Petty cash book
Miscellaneous General journal

Once the transactions have entered into the books of original entry, then the information is later
entered into the ledger accounts by means of the double entry system. This is called posting.

Sales transactions are posted to the sales ledger

Purchases transactions are posted to the purchase’s ledger

Items involving the real and nominal accounts are posted to the general ledger.

Then at the end of each month the accounts are closed and balanced off and a trial balance is
prepared to help check arithmetic accuracy of the book keeping entries. Then at the end of the final
year the trial balance is used to prepare the final accounts.

Exercise
1. Source documents are very important.
a. Describe the contents of both an invoice and a credit note
b. State when each of these would be used
2. The books of original entry are used to record initial accounting information and separate
books are used for different types of transactions. List the various books used and give a
brief explanation as to how each one is used.
3. For what purpose would you use the following ledgers:
a. General or nominal ledger
b. Sales ledger
c. Purchases ledger
4. Distinguish between personal and impersonal accounts giving examples of what each might
contain.