Business 2005

1. WHAT IS A BOOKKEEPING SYSTEM?

WHAT IS A BOOKKEEPING SYSTEM?

Design, implementation, and maintenance of a suitable bookkeeping system is one of the most important tasks of the financial manager.

The Bookkeeping System may be a manual or a computerized one.

At this stage the Manual Bookkeeping System will be discussed to enable you to understand the basic bookkeeping principles. This system, also known as a Double-Entry Bookkeeping System, consists of Sets Of Records, or Sets Of Books, and formal instructions for placing information in those books.

THE BASIC RULE OF THE DOUBLE-ENTRY BOOKKEEPING SYSTEM

The Basic Rule Of Double-Entry Bookkeeping states the following:

"Every transaction affects at least two accounts"

2. WHAT IS AN ACCOUNT?

AN ACCOUNT

Each Account represents one item that appears on the financial statements, i.e. an asset, liability or owner's equity.

In its simplest form, an account consists of three parts, as outlined below. This form of the account is termed a "T"- Account because of its similarity to the letter "T". An ordinary "T"-Account is illustrated below.

THREE PARTS OF AN ACCOUNT
No.	Details
1	A Title that describes the account.
2	The left side, or the Debit side.
3	The right side, or the Credit side.

"T"-ACCOUNT

3. ELEMENTS OF A "T"- ACCOUNT

There are several Basic Accounting Terms and Entries in accordance with the accounting terminology, as illustrated below.

BASIC ACCOUNTING TERMS


The term "Debit" means "left", from the Latin word *Debere.* (abbreviated Dr.)		The term "Credit" means "right", from the Latin word *Credere.* (abbreviated Cr.)

Therefore:

BASIC ACCOUNTING ENTRIES


Every entry made on the left side of the "T"-Account is called a Debit, or a Debit Entry.		Every entry made on the right side of the "T"-Account is called a Credit, or a Credit Entry.

The terms "Debit" and "Credit" are also used by accountants as verbs, as illustrated below.

BASIC TYPES OF ACCOUNTING RECORDING


The act of recording a "Debit" in a specific account is called *debiting the account.*		The act of recording a "Credit" in a specific account is called *crediting the account.*

4. WHAT IS A CHART OF ACCOUNTS?

A CHART OF ACCOUNTS

In an ordinary Accounting System, all accounts are classified under suitable headings and coded numerically for easier reference.

A list of such coded accounts is known as a Chart Of Accounts and comprises five basic categories, as illustrated below.

FIVE BASIC CATEGORIES OF A CHART OF ACCOUNT


Assets	Liabilities	Shareholders' Equity	Revenues	Expenses

5. WHAT ARE ASSETS?

WHAT ARE ASSETS?

Assets represent total resources controlled by the organization and utilized for the purpose of obtaining future benefits.

Assets are provided to the organization by two prime sources, as illustrated below.

TWO PRIME SOURCES OF ASSETS


Owners Or Shareholders		Outside Investors

Total Company Assets

As a result of their investment, Shareholders and Creditors acquire a special interest in the organization, which is respectively termed, as illustrated below.

SHAREHOLDERS' AND CREDITORS' INTEREST IN A COMPANY


Shareholders' Equity		Creditors' Claims

THE BASIC ACCOUNTING EQUATION

According to the Basic Accounting Equation:

Assets = Creditors’ Claim + Shareholders’ Equity

6. WHAT ARE LIABILITIES?

WHAT ARE LIABILITIES?

Liabilities represent the total creditors' claims against assets utilized by the organization.

In other words, liabilities represent the total debt of the organization. Such a debt may include money owed by the organization to its employees, suppliers, banks, tax authorities, and various creditors.

Thus, according to the Basic Accounting Equation:

Liabilities = Creditors’ Claims = Assets - Shareholders’ Equity

7. WHAT IS SHAREHOLDERS’ EQUITY

WHAT IS SHAREHOLDERS’ EQUITY?

Shareholders' Equity represents the owners' interest in the organization and is equal to the net worth of the company.

The total value of the shareholders' equity represents the excess of total company assets over total company liabilities.

Thus, according to the Basic Accounting Equation:

Shareholders’ Equity = Net Worth = Assets - Liabilities

8. WHAT ARE REVENUES?

WHAT ARE REVENUES?

Revenues represent the total value earned (not necessarily collected) by an organization during a specified accounting period.

Service organizations, for example, earn revenue by rendering service to customers. The revenue earned may be in either the form of cash or as a receivable. Merchandising and manufacturing organizations, on the other hand, earn revenues as a result of delivering goods to customers. Thus:

Revenues = Total Fees Earned By An Organization

9. WHAT ARE EXPENSES?

WHAT ARE EXPENSES?

Expenses represent the total cost incurred (not necessarily paid) for services rendered or goods sold by an organization during a specified accounting period.

Thus:

Expenses = Total Cost Of Sales Incurred By An Organization

10. CLASSIFICATION OF MAIN ACCOUNTS

The above mentioned Main Accounts may further be sub-divided into various groups, depending upon the specific nature of the company's activities, as illustrated below.

ASSETS


Current Assets		Capital Assets		Long-Term Investments		Intangible Assets

LIABILITIES


Current Liabilities		Long-Term Liabilities

REVENUES


Revenues From Services		Gross Sales		Net Sales

EXPENSES


Cost Of Goods Manufactured		Cost Of Goods Available For Sale		Cost Of Goods Sold		Operating Expenses

11. THE BASIC REQUIREMENT OF A DOUBLE-ENTRY BOOKKEEPING SYSTEM

THE BASIC REQUIREMENT OF A DOUBLE-ENTRY BOOKKEEPING SYSTEM

The basic requirement of a Double-Entry Bookkeeping System is the equality of all debits and all credits, i.e.:

Total Debits = Total Credits

Thus, according to this requirement:

Equal amounts of debit and credit entries must be recorded for every business transaction.

A method of recording these transactions for different types of accounts is presented below.

12. THE FUNDAMENTAL RULES FOR RECORDING TRANSACTIONS IN A DOUBLE-ENTRY ACCOUNTING SYSTEM

The fundamental rules for recording transactions in a Double-Entry Bookkeeping System are illustrated below.

THE FUNDAMENTAL RULES FOR RECORDING TRANSACTIONS IN A DOUBLE-ENTRY ACCOUNTING SYSTEM
Type Of Account	Accounting Rule
Assets	Increases in assets are *debited* to asset accounts. Decreases in assets are *credited* to assets accounts.
Liabilities	Increases in liabilities are *credited* to liability accounts. Decreases in liabilities are *debited* to liability accounts.
Shareholders' Equity	Increases in shareholders' equity are *credited* to the shareholders' equity account. Decreases in shareholders' equity are *debited* to the shareholders' equity account.
Expenses And Withdrawals	Increases in expenses and withdrawals by *debits decrease* the shareholders' equity account. Decreases in expenses and withdrawals by credits increase the shareholders' equity account.
Revenues	Increases in revenues by *credits increase* the shareholders' equity account. Decreases in revenues by *debits decrease* the shareholders' equity account.

The Method Of Recording Transactions is illustrated below.

THE METHOD OF RECORDING TRANSACTIONS


Assets	=	Liabilities	+	Shareholders Equity

THE METHOD OF RECORDING TRANSACTIONS

© Needles, B.E., Jr., H.R. Anderson, J.C. Caldwell, and Mills, S.K., Financial & Managerial Accounting, 4th ed. pp. 56 (Adapted), Copyright 1996 by Houghton Mifflin Company. Used with permission. All rights reserved.

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13. TWO TYPES OF ACCOUNTING BOOKS

An ordinary bookkeeping system consists of Two Types Of Accounting Books, or Books Of Account, as illustrated below.

TWO TYPES OF ACCOUNTING BOOKS


Journal		Ledger
This accounting book facilitates the initial entry in a chronological sequence of all transactions from the source documents. The process of entering transactions into the journal is called journalizing.		This accounting book facilitates the transfer of all journal entries in a chronological sequence to individual accounts. The process of recording journal entries into the ledger is called *posting.*

14. SMALL BUSINESS EXAMPLE:
TYPICAL APPLICATION OF TRANSACTION RULES
IN A DOUBLE-ENTRY ACCOUNTING SYSTEM

© Needles, BYE., Jr., H.R. Anderson, J.C. Caldwell, and Mills, S.K., Financial & Managerial Accounting, 4th ed. pp. 58-59 (Adapted), Copyright 1996 by Houghton Mifflin Company. Used with permission. All rights reserved.

15. STANDARD BOOKKEEPING PROCEDURE IN AN ACCOUNTING CYCLE

STANDARD BOOKKEEPING PROCEDURE

The standard procedure for recording transactions in a double-entry bookkeeping system represents an integral part of the Accounting Cycle.