The following diagram summarises the process to prepare the annual financial statements, from entering into transactions and recording those transactions in the accounting system and then progressing to preparation of the annual financial statements. The recording of transactions is performed using the principles of double-entry bookkeeping.
The remaining part of this chapter will focus upon accounting systems and processes and, in subsequent chapters, progress to recording transactions and the preparation of the trial balance and the correction of errors.
Note that the ACCA FA1 syllabus and exam includes year-end adjustments such as the correction of errors in the trial balance. The ACCA FA1 syllabus and exam does not include preparation of the annual financial statements.
When an accounting transaction has occurred, it must be recorded in the accounting system using double-entry bookkeeping principles. This requires a source document that provides evidence or information about the transaction to be recorded. Source documents will be referenced with account names or codes, along with monetary amounts, to enable transactions to be recorded appropriately in the accounting system.
Depending upon the nature of the transaction, data recorded is likely to include the following:
Note that not all business documentation referred to in chapter 2 is a source document for recording transactions in the accounting system and this is considered in the following section. We can now move on to explain the process to record those transactions in the accounting system as a basis for preparing useful accounting information and the trial balance.
In most businesses, classification and recording of each transaction is allocated to specific ledger accounts. For example, there will be a separate ledger account for each source of income (such as sales and interest received) and each type of expense (such as purchases, rent, wages and insurance).
There will also be asset accounts (for items such as property, plant and equipment and amounts due from credit customers) along with liability accounts (such as amounts outstanding to suppliers, bank loans and sales tax due). There is no rule or limit as to how many general ledger accounts a business should have but the system should enable effective and efficient accounting and control.
Before we look in detail at how transactions are recorded and processed in the accounting system some terminology should be explained.
The term 'general ledger' refers to the complete set of ledger accounts used by a business in which transactions are recorded. It may also be referred to as a 'nominal ledger' or 'chart of accounts'. It forms the basis of financial accounting information used to produce a trial balance and, subsequently, the annual financial statements.
A ledger account contains a record of transactions assigned to a specific asset, liability, source of income or expense, along with a capital account for a sole proprietor. It will identify increases and decreases in that item during an accounting period. Collectively, the ledger accounts contain the record of accounting entries relating to all transactions and events during an accounting period. They are the principal books or files for recording, summarising and totalling monetary transactions by account item or type. The trial balance and annual financial statements of a business are generated from summary totals in the ledger accounts contained in the general ledger.
Irrespective of the size and complexity of a business, an accounting system has three components as illustrated below.
Source documents include sales and purchase invoices, credit notes, payroll totals, petty cash summaries, summaries of bank receipts and payments and journals.
Standing data is data used repeatedly to assist with the processing of recurring or regular transactions and will include data such as price lists, wage rates, sales tax rates, customer account details and supplier account details.
Source documents must be referenced with the general ledger account codes to be updated as appropriate. A source document will normally require a minimum of two general ledger account codes. More than two general ledger codes may be required if, for example, sales tax needs to be accounted for, or a purchase invoice includes more than one item purchased.
In a computerised system, source documents are also be referenced or coded to enable simultaneous update of 'memorandum only' accounting information. Examples of memorandum only accounting information include inventory usage reports and payroll analyses. Consequently, this means that when 'memorandum only' accounting information is recorded, it will match exactly the information recorded in the general ledger accounts.
Although these records are updated simultaneously when the general ledger accounts are updated, it is important to remember that 'memorandum only' information does not form part of the double-entry bookkeeping system. 'Memorandum only' information is used to enable managers to monitor and control the business, for example, to ensure that credit customers pay the amount due within the agreed credit period.
Not all of the business documents explained in chapter 2 are source documents used to update the accounting system. For example, a supplier statement provides a summary of transactions recorded by a supplier within the previous month and issued to a customer. It is not a source document used by either the supplier or the customer to update their respective accounting systems. Similarly, a remittance advice provides information relating to a payment made, although it is not the payment itself.
As you progress through this chapter, examples of how documents are coded so that they can be recorded in the accounting system will be explained and illustrated.
The key process is to record transactions, which may be done in real-time so that updating takes place at the time the transaction takes place, or batch processing at appropriate intervals e.g. daily, weekly as required.
In addition, systems will also perform tasks of calculating, classifying and summarising data, such as the monetary total of sales invoices issued during a specified period, or providing an analysis of expenses incurred during a specified period.
Finally, processing includes the updating general ledger accounts and the 'memorandum only' accounting information to provide management information.
The primary outputs of an accounting system are the trial balance and financial statements (or selected extracts as required).
Reports, such as aged analysis of receivables' ledger accounts, payroll summaries and payslips, inventory usage summaries, analysis of expenses and exception reports can normally be obtained from most computerised accounting systems. This is useful financial information to help manage and control the activities and operations of the business.
Historically, it would have been a manual process to record transactions in handwritten books or ledgers. Although the components of the system have not changed, as the size and complexity of businesses have increased and manual accounting systems have largely been replaced by computerised systems.
The ACCA FA1 syllabus and exam assumes that computerised accounting systems and processes are used, although knowledge of specific computer packages and programs is not required.
In addition to preparing the trial balance and annual financial statements, the accounting system is also used to monitor the effectiveness of the business and to help review and conclude relevant transactions. For this reason, additional data is recorded in the accounting system. The 'memorandum only' data is summarised and classified to provide information in a form useful for management decision-making and control of the business.
Examples of such information include:
In the case of credit sales, credit controllers require information from the accounting system to identify which customers have not settled their debts and, for that reason, who should be contacted to remind them that payment is due. Equally, for suppliers who have granted a period of credit to the business, there is a need to review which account payables are due for payment, and how much that payment should be.
Therefore, for goods purchased or sold on credit, individual customer or supplier accounts need to be set up within the accounting system, and each will have an individual supplier or customer account code. These accounts will be created using a standardised procedure and done under the supervision of a suitably responsible person such as a senior member of the accounting department. They will normally be subject to controls and checks to ensure that they are valid accounts.