Accounting principles

The Bookkeeping and Accounting Cycle

With reference to the diagram, the accounting cycle is a yearly cycle, which includes the bookkeeping cycle. In some businesses, the accounting cycle is a quarterly or even a monthly cycle. The bookkeeping cycle runs on a monthly basis. In this course, we are going to go through each of the steps in the accounting cycle to give you an understanding of the responsibilities of a bookkeeper.

Transaction

At this stage of the process, the transaction will take place. This is then recorded in the next step of the cycle.

Source Documents

Source documents are used to record a transaction and are then kept as proof of the transaction. The information is taken from the source document and written into the subsidiary journal. It is essential that source documents are filed safely as SARS (South African Revenue Services) requires that they are kept for five years. It is also very important that source documents are kept in an orderly filing system. This makes it much easier to find documentation that you might need, for example, to solve a query or prove that a payment was made. Examples of source documents include:

  • Invoices (duplicate and original).
  • Credit notes (duplicate and original).
  • Receipts.
  • Deposit books/slips.
  • EFTs.
  • Cheque counterfoils.
  • Bank statements.

Subsidiary Journals

Subsidiary journals are used to group and summarise the transactional information from the source documents of a company. A business will use a number of subsidiary journals, in which transactions of a particular type are recorded, depending on the size and diversity of the business. Below are examples of the subsidiary journals that a company would typically use and the source documents from which the information comes.

Petty cash journal Journal to record all of the petty cash transactions of a business. A business will generally use petty cash voucher slips to record the transactions.
Cash book receipts Recording of all of the receipts into the bank account that a business has received. A business will use either its deposit slips or receipts as its source document.
Cash book payments All payments made from a bank account are recorded, using cheque counterfoils as the source document.
Sales journal / debtors journal Records all of the customer invoices issued by a business, whether for cash or on credit. The duplicate invoices we have issued will be used in this instance.
Purchases journal / creditors journal Invoices from suppliers/creditors are recorded. An original invoice will be our source document in this instance.
General journal Miscellaneous transactions, such as payroll control transactions and drawings that do not fit into any of the other journals, are captured in the general journal. Any type of other source document can be used here, such as a cash requisition form from the owner for cash.

Reconciliation

Once all of the source document entries for a month have been captured into a journal, reconciliations are done to ensure that they have been done correctly. For example, a bank reconciliation is done by comparing the cash books with the bank statement and a creditor reconciliation is done by comparing the purchases journal and the creditor’s statements.

The reconciliation process is a very important and often neglected step in the bookkeeping cycle. It is vitally important to a business that the financial records are accurate. You will never know that your work is correct unless you check it against documents from another source.

General Ledger

The general ledger is used to bring all of the information from the subsidiary journals into one place. When transferring/posting information from the journals into the general ledger, two entries are made for each transaction. This process is called the “Double Entry System”.

Trial Balance

A trial balance is a report or list showing all of the balances from the general ledger. It can also be used to make sure that the balances on all of the accounts are correct, as it will show if there is an entry missing. It does not show if entries have been made into the incorrect accounts or if the value transferred from the journals to the general ledger were incorrect.

Statement of Comprehensive Income

On a periodic basis a statement of comprehensive income is drawn up from the general ledger. This report shows all of the income versus the expenditure of the business over the period and is used to show the profitability or losses of the business.

Statement of Financial Position

A statement of financial position is also drawn up from the general ledger on a periodic basis. This report shows the assets, liabilities and owner’s equity of the company, giving an indication of the long-term viability of the business.

Now that you have an understanding of how transactions are recorded in the general ledger, we will process some transactions.

The Accounting Equation

Introduction

From the large corporation down to the corner shop, every business transaction will have an effect on a company’s financial position. The financial position of a company is measured by the following items:

  • Assets (what the company owns).
  • Liabilities (what the company owes to others).
  • Owner’s Equity (the difference between the assets and liabilities).

The accounting equation (or basic accounting equation) offers a simple way to understand how these three amounts relate to each other.

The formulas for the accounting equation are as follows:

Owner’s Equity = Assets – Liabilities (O = A – L)
Assets = Liabilities + Owner’s Equity (A = L + O)
Liabilities = Assets – Owner’s Equity (L = A – O)

Assets

The value of everything owned and used in a business is considered an asset, such as cash, office equipment and stock. For example, the computers, copier machines and office furniture are its assets. Assets even include any money owed to a business, known as “Accounts Receivable”.

Liabilities

The amount of money the company owes a person or company for goods or services rendered is considered a liability. For example, when a company buys office supplies and charges them to an account with an oral or implied promise to pay, these charges are considered a liability and are often classified as “Accounts Payable”. In addition, when a company borrows money from a bank, the loan is a liability.

Owner’s Equity (Capital minus Drawings)

The part of the company that belongs to the owner is the owner’s equity. Owner’s equity can be determined by finding the difference between a company’s assets and liabilities; the difference is what a company is worth to the owner.

Income vs Expenses

Income and expenses are two categories that are included in owner’s equity.

Income is monies that a company earns from selling goods or services to another firm or individual. The term income is often used when referring to revenue accounts. For example, the income account for a cinema might include ticket income and concession income.

Expenses are the costs of goods or services that a company buys and uses to help earn income. Examples of an expense account might include rent expense, utilities expense, and insurance expense.

Income and expense transactions tell whether a company is making a profit or incurring a loss from its operations. If the income total is larger than the expense total, there is a net profit. If the expenses are larger than the income, there is a net loss.

See below a map of the accounting equation: