Steps In The Bookkeeping Process

When starting in business it is good to have a bit of an idea about bookkeeping.  Although you most likely will hire someone to either keep the books for you inside or outside the office, it is still important to have an overall idea about the steps taken in this process as well as an overall idea as to what is being done. There are generally five steps in the bookkeeping process:

  1. When a transaction occurs there is some original paperwork involved such as an invoice, a credit note, a receipt or petty cash voucher, etc.  This original documentation must be retained and filed away where it can be easily found and referred to if necessary.
  2. Details from the original paperwork are recorded in the "original books of entry". These are records such as the cash book, purchases book, sales book, petty cash book or sales returns book.
  3. The details written into the books of original entry are transferred to the ledger. The ledger is the main book of accounts which records all debits and credits in the business operations.
  4. A trial balance can be made when required by adding the debit column and adding the credit column, and comparing the two additions to determine the current state of financial affairs. If credits are greater than debits, then you are making money; but if debits are greater, you are losing money.
  5. The ledger is used to prepare a set of final accounts at the end of a given period, normally at the end of each financial year. These final accounts include such things as a Profit and Loss account, a Balance sheet and a Trading account. These accounts may be necessary for taxation or other purposes.

Do You Understand The Basics Of Bookkeeping?

What is a ledger account?

A ledger account is a listing or financial record of all transactions which relate to a particular item in a business (e.g. all details related to rent would be recorded in the rent account).  All ledger accounts are maintained together in the general ledger.  The terms appear to be somewhat interchangeable, with ‘ledger’ encompassing ‘account’ and ‘general ledger’ encompassing ‘ledger’.

What are the three parts of an entry in a ledger account?

The three parts of an entry into a ledger account are:

  1. the date of the transaction
  2. the name of the other account affected
  3. the pound value of the transaction

What is the difference between ‘footing’ a ledger account and ‘balancing’ a ledger account?

‘Footing’ of a ledger account is an informal process, usually done in pencil, at any time during the accounting period.  ‘Balancing’ a ledger account is a formal process done at the end of the accounting period.  These balances are included in the business’s balance sheet.  This procedure then becomes part of the business’s permanent record.

What is a trial balance?

A trial balance is a list of all accounts in the general ledger at a particular date and is used to check the accuracy of the general ledger.  To complete a trial balance all accounts are balanced, these balances are then transferred to the trial balance to ensure there are no discrepancies in the figures.  However, it is not a fool-proof method.  Errors may occur on several occasions, including if both the debit and credit entries of a transaction are missed or if the debit and credit in a transaction was mistakenly reversed, if the wrong amount was used, using the wrong account, entering a transaction twice or making two errors that cancel each other out.

The major advantages of three-column ledger accounts compared with T-form ledger accounts.

Major advantages would involve the inclusion of the date of the transaction and a folio column which allows for easier tracking of the two entries in a transaction.  T-form ledger accounts do not include either of these items (it is simpler – it includes a running balance and therefore footing and balancing is not required as in T-form).

What are the functions and classifications of a ‘drawings’ account? 

A ‘drawings’ account is used to track the transactions of the owner of the business - that is, when or if the owner withdraws assets, most commonly cash, for personal use, this is recorded in the drawings account.  The classification of this account lies under Proprietorship.  It is the opposite entry to that which occurs when the owner invests in the business.

  • Assets: these are items of value owned by the business.
  • Liabilities: these are debts owed by the business to outsiders
  • Proprietorship: this is the owner’s claim on the assets of the business.  It is also referred to as the net worth of the business.  It may consist of the capital the owner has contributed to the business plus any profits earned by the business which have not been withdrawn.
  • T-form balance sheet: a T-form balance sheet shows the basic balance sheet equation across the page.
  • Narrative form balance sheet: the narrative format is prepared in vertical form down the page.
  • Current assets: this heading includes all assets (i.e. cash, debtors) which are normally expected or intended to be turned into cash or used up within the next 12 months.
  • Non-current assets: these are longer term assets (e.g. equipment, investments); they are usually purchased with the intention of owning them for a period greater than 12 months for the purpose of generating income for the business.
  • Current liabilities: this includes all debts to outsiders (e.g. creditors, bank overdraft) which are due for repayment with the next 12 months.
  • Deferred liabilities: these are the longer term debts (e.g. long-term loan, mortgage loan) and are also known as non-current liabilities. They are debts where the repayments have been deferred over a period greater than 12 months.  Long-term loans such as mortgage a loan is another typical example.

Double Entry Bookkeeping

This is based on the notion that for each creditor there must be a debtor e.g. if someone sells something, someone else must buy it, or if someone is paid for a service, someone else must pay them for that service. It is a system of recording all the payments out, and payments in, of a business. For each transaction at least two entries are made into the ledger - one being a credit and one being a debit, hence the term 'double entry'. 

Keeping accurate entries for debits and credits makes accurate accounting much easier to prove by totaling the credit and debit columns which should be equal. If an error was made during the entry of data into either column it will be easy to find. Double entry bookkeeping also makes record keeping more orderly and is very useful when creating profit and loss statements, or equity, assets and liabilities statements.

Single Entry Bookkeeping

By comparison to double entry bookkeeping, this is a more basic system of recording data. It is generally used where detailed accounts are not required e.g. the tax statement of an individual who is a self-employed sole business who is providing a service but not goods.

A single entry recording system does not include debit and credit columns but instead simple entries for things like cash, tax paid, accounts payable and accounts receivable. Information kept in a single entry bookkeeping system may be used to create statements of income and balance sheets.  

The type of records kept may vary considerably, but generally include:

  • Cash receipts
  • Cash payments - expenses associated with the business
  • Debtor accounts - a record of the amounts owed, and by whom
  • Assets and liabilities - records of these are often poorly kept in this system

This method of keeping records is less accurate and makes profit and loss statements and balance sheets more prone to error.

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