Bookkeeping is defined as keeping records of financial transactions involving the company. Examples of such records include a daily cash sheet and ledgers for accounts receivables and accounts payables among others. Bookkeeping is important for three reasons: one, it keeps track of the company’s money. It also helps show how the company is performing on daily, weekly or monthly basis. The third is to make it easier to prepare the company’s income tax return. There are many general accounting systems that all small businesses are expected to have. A basic system includes these elements:
1. A journal for purchases
This document details all of the purchases made under the company’s name. Purchases can come in the form supplies or equipment or items that would later be resold on the market. Information regarding the purchased items will be copied onto the general ledger. Any purchases made using credit will be transferred on to the accounts payable ledger.
2. A ledger for accounts payable
Sometimes labeled as the creditors ledger, the accounts payable ledger includes a list of all items and purchases obtained through credit. This ledger will sum up all of the amounts owed to other companies or businesses and help maintain a healthy business relationship with suppliers.
3. A ledger for accounts receivable
This particular ledger is also known as the debtor ledger. If the accounts payable is meant to be a detailed list of what the company owes to other companies, this will detail all of the funds that other people or companies owe you. Your business needs this to determine how much to collect from each client.
4. A general ledger
The general ledger sums up all of the transactions involving the business. Entries are copied from the cash book and the journals. Adjustments will be main to account for accruals and other non-cash transactions. A detailed general ledger is often used to create the financial report.
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5. A cash book
A cash book basically includes all of the financial transactions that involve the business, with corresponding receipts. It shows how the money goes in and out of the business. Any cash received is documented with details transferred to the accounts receivable and general ledgers. Transactions that involve paying out are copied to the accounts payable and general ledgers. The amounts are compared with the company’s bank statements to ensure that the right amount is still inside the account.
6. Petty Cash
Most cash set money aside to pay for small, miscellaneous expenses such as transportation and stamps. A check is made payable to petty cash and indicated as a miscellaneous expense on the ledger. The check is en-cashed and placed into the cash box. Small amounts are withdrawn to pay for miscellaneous items. A receipt or a note of what was purchased is placed into the cash box.
Two Types of Accounting Systems
1. Cash Accounting
This type of accounting system records and includes details of transactions that involve actual cash flow. Income is recorded every time the company receives a payment in the form of cash, check or credit card. Expenses are detailed when the company pays for products and services in the form of cash, check or credit card. Additional forms of payment are available and will vary from one company to another.
2. Accrual Accounting
With this type of system, details of the transaction are included regardless of whether cash changed hands or not. For instance, a customer purchases goods from the company on October and decides to pay on December. With using the accrual system, the transaction is listed at the time it occurred. Using this example, this would be October. With the cash accounting system, the transaction is only listed when the payment is received, which is December in this case.
Accrual vs. Cash Accounting Systems
There are advantages and disadvantages to using both systems. With using cash accounting, entrepreneurs get a better idea of how the cash flows. On the other hand, following the accrual accounting system will let you see the bigger picture and determine whether the business is actually making or losing money. But because the system requires additional details, accountants need to know how to use the accounting equation and perform double-entry bookkeeping.
The IRS allows companies to choose and use from these two types of accounting systems. However, there are additional stipulations to consider. If the company makes gross sales revenues of more than $5 million dollars, has an inventory or is considered a C corporation, then the company is advised to utilize the accrual accounting system.