The Use of Accounting System in Reality


Talking about accounting systems, accounting systems vary widely from one business to another, it depends on

  • Nature of the business
  • The size of the firm
  • The volume of data
  • The informational demands.

Accounting systems include all of the activities required to provide management with the information for planning, controlling and reporting the financial condition and operations of an enterprise.

If we look at a balance sheet with “T” account format, the terms DEBIT mean left side and the terms CREDIT mean right side. These terms do not mean increase or decrease. The equality of debits on the left side and credits on the right side provides the basis for the DOUBLE – ENTRY SYSTEM or DOUBLE – ENTRY BOOK KEEPING of recording transactions. The used double entry accounting system or the dual or two sided effect of each transaction in appropriate accounts. This system provides a logical method for recording transactions and proving the accuracy of the recorded amounts. If every transaction is recorded with equal debits and credits, then the sum of all the debits to the accounts must equal with the sum of all the credits or total debits must equal with total credits. In a double system every debit there must be follow with a credit and vice-versa.

There are three basic guidelines for an accounting system

  1. All asset and expense accounts are increased on debit or the left side and decreased on credit or the right side.

  1. All liability and revenue accounts are increased on credit or the right side and decreased on debit or the left side.

  1. Stockholders’ equity accounts like common stock and retained earnings are increased on credit or right side whereas dividends is increased on debit or the left side.

Balance sheet and Income statement as Financial statement related to ownership structures

Investments by stockholders called common stock and retained earnings comes from net income retained in business are reported in the stockholders’ equity section of the balance sheet.

Dividends are reported on the statement of retained earnings. Revenue and expenses are reported on the income statement.

Dividends, revenues and expenses are eventually transferred to retained earnings at the end of the period. It means dividends and net income or net loss are eventually transferred to retained earnings at the end of the period.

The type of ownership structure employed by a business enterprise affect the equity section. In a corporation there are accounts commonly used such as

  • Common stock
  • Additional Paid – in Capital
  • Dividends
  • Retained Earnings

In a proprietorship or patnership, a “Capital Account” is used to indicate the owner’s investment in the company. A “Drawing Account” is used to indicate with drawals by the owner.

Effects of transactions on owners’ equity accounts

A. In corporations

A1. Investment by owners

When owners invest in exchange for common stocks, this transaction impact on increasing owners’ equity called “Common Stock” in a balance sheet.
For example, owners invest $130,000 in exchange for common stocks to use for buying some equipments. Debit or the left side of assets (equipment account) will increase $130,000 and credit or the right side of owners’ equity (common stock account) will increase $130,000

A2. Revenue earned

When a company gets revenue, this transaction impact on increasing owners’ equity called “Retained Earnings” in a balance sheet, at the end of the period. However at the time when a company receives the revenue in cash, assets (cash account) on the left side or debit will increase and credit or the right side of owners’ equity (a temporary account called revenue account) will increase. At the end of the period, total amounts in temporary account called revenue account will be transferred to Retained Earnings to increase owners’ equity called Retained Earnings in a balance sheet.
For example, at the time when a company gets revenue $4,000 in cash, cash account will be debited $4,000 and a temporary account called revenue account will be credited $4,000. At the end of the period $4,000 on revenue account will be transferred to owners’ equity – retained earnings on a balance sheet to increase owners’ equity.

A3. Expenses incurred

When a company pays wages, this transaction impact on decreasing owners’ equity called “Retained Earnings” in a balace sheet, at the end of the period. However at the time when a company pays wages in cash, a temporary account called expense account on the left side or debit will increase and credit or the right side of cash account will decrease. At the end of the period, total amounts in temporary account called expense account will be transferred to Retained Earnings to decrease owners’ equity called Retained Earnings in a balance sheet.
For example, at the time when a company pays wages $1,600 in cash, a temporary account called expenses account will be debited $1,600 and cash account will be credited $1,600. At the end of the period $1,600 on expenses account will be transferred to owners’ equity – retained earnings on a balance sheet to decrease owners’ equity.

A4. Withdrawal by owners

Withdrawal by owners in corporations called “Dividends”. This transaction impact on decreasing owners’ equity called “Retained Earnings” in a balance sheet, at the end of the period. However at the time when a company pays dividends in cash, a temporary account called dividends account on the left side or debit will increase and credit or the right side of cash account will decrease. At the end of the period, total amounts in temporary account called dividends account will be transferred to Retained Earnings to decrease owners’ equity called Retained Earnings in a balance sheet.
For example, at the time when a company pays dividends $5,500 in cash, a temporary account called dividends account will be debited $5,500 and cash account will be credited $5,500. At the end of the period $5,500 on dividends account will be transferred to owners’ equity – retained earnings on a balance sheet to decrease owners’ equity.

When a company declare to pay dividends, a temporary account called dividends account on the left side or debit will increase and credit or the right side of liability account  will increase. At the end of the period, total amounts in temporary account called dividends account will be transferred to Retained Earnings to decrease owners’ equity called Retained Earnings in a balance sheet. At the time when a company pays dividends in cash, liability account will be debited and cash account will be credited.

B. In proprietorships and patnerships

B1. Investment by owners

When owners invest, this transaction impact on increasing owners’ equity called “Capital” in a balance sheet.
For example, owners invest $130,000 to use for buying some equipments. Debit or the left side of assets (equipment account) will increase $130,000 and credit or the right side of owners’ equity (capital account) will increase $130,000

B2. Revenue earned

When a company gets revenue, this transaction impact on increasing owners’ equity called “Capital” in a balance sheet. However at the time when a company receives the revenue in cash, assets (cash account) on the left side or debit will increase and credit or the right side of owners’ equity (a temporary account called revenue account) will increase. At the end of the period, total amounts in temporary account called revenue account will be transferred to Capital in a balance sheet to increase owners’ equity.
For example, at the time when a company gets revenue $4,000 in cash, cash account will be debited $4,000 and a temporary account called revenue account will be credited $4,000. At the end of the period $4,000 on revenue account will be transferred to owners’ equity – capital on a balance sheet to increase owners’ equity.

B3. Expenses incurred

When a company pays wages, this transaction impact on decreasing owners’ equity called “Capital” in a balace sheet. However at the time when a company pays wages in cash, a temporary account called expense account on the left side or debit will increase and credit or the right side of cash account will decrease. At the end of the period, total amounts in temporary account called expense account will be transferred to Capital in a balance sheet to decrease owners’ equity.
For example, at the time when a company pays wages $1,600 in cash, a temporary account called expenses account will be debited $1,600 and cash account will be credited $1,600. At the end of the period $1,600 on expenses account will be transferred to owners’ equity – capital on a balance sheet to decrease owners’ equity.

B4. Withdrawal by owners

The impact of withdrawal by owners will decrease owners’ equity called “Capital” in a balance sheet. However at the time when owners drawing in cash, a temporary account called drawing account on the left side or debit will increase and credit or the right side of cash account will decrease. At the end of the period, total amounts in temporary account called drawing account will be transferred to Capital in a balance sheet to decrease owners’ equity.
For example, at the time when owners witdraw $5,500 in cash, a temporary account called drawing account will be debited $5,500 and cash account will be credited $5,500. At the end of the period $5,500 on drawing account will be transferred to owners’ equity – capital on a balance sheet to decrease owners’ equity.

The first step in accounting cycle is analysis of each sale or purchase transaction, no matter how small it is, it should be recorded. The transactions and events that affect a business enterprise is used to describe th source of changes in an entity’s assets, liabilities and equity. There are many events that have both external and internal elements however there are only two types of events

A.  External events

Involve interaction between an entity and its environment such as a transaction with another entity or a change in the price of a good or service that an entity buys or sells or an improvement in technology by a competitor.

B.  Internal events

Occur within an entity, such as using buildings and machinery in its operations or consuming raw materials in production processes.

Transactions as particular kind of external events, may be an exchange in which each entity receives and sacrifices value such as purchases and sales of goods or services. Transactions may be transfers in one direction to another entity without directly receiving or giving value in exchange, such as investments by owners, distributions to owners, payment of taxes, etc.

In short, accountants record as many events as possible that affect the financial position of enterprise. Some events are omitted because the problem of measuring them are too complex. To have a complete record of each transaction concern with asset, liability, equity, revenue and expense items in one place, a journal called GENERAL JOURNAL as the book of original entry is employed. General journal is a simplest journal form as a chronological listing of transactions and events expressed in terms of debits and credits to particular accounts.

Most businesses use SPECIAL JOURNALS such as

  • Cash receipts journal
  • Sales journal
  • Purchases journal (Voucher register)
  • Cash payments journal (Check register)

in addition to the GENERAL JOURNAL.  

Using general journal nor special journal is kind of  the most fundamental  process of recording that must be done carefully before posting process to the ledger, trial balance, adjustment process until reversing entries.  Any error on recording process with journal have impact on the subsequent process however the good result of recording with journal does not guarantee free of errors in the subsequent processes. This process must be taken when you follow on accounting system in reality.  

You may send your comment to   george.hamilton79@gmail.com

and visit http://www.gbu007.blogspot.com

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