what is bookkeeping?
Obviously, in the most basic sense, it means the recording of financial transactions. But what does that mean? What is actually involved?
In the normal course of business, documents are produced each time a transaction occurs. Documents are the starting point in a sequence of events
that eventually lead to the annual accounts, or financial statements. For purchases, we have invoices and receipts for the items bought. Since they also have to be paid for, traditionally there will also be cheque book stubs. However, today, we are just as likely to find payments made by card as by cheque, and then we would have card swipe receipts. For sales, we would have sales invoices or till rolls and paying in books or BACS credit advice notes.
There are two broads systems of bookkeeping – single entry bookkeeping and double entry bookkeeping. For most small businesses, single entry is sufficient. In single entry bookkeeping, each transaction is recorded once.
single entry bookkeeping
The primary bookkeeping entry in single entry bookkeeping is the Cash Book. As you would expect, this is driven by payments and receipts made or received. It would consist of a spread sheet with each payment analysed out into an appropriate category. Today, we are all familiar with spread sheets with products like Microsoft Excel.
But the actual term comes from the pre-computer age, when spread sheets consisted of large fold out sheets with multiple rows and columns. The bookkeeper would enter each payment into the total and the individual category column. At the bottom of the sheet, each column would be totalled and at the far right, each row would be totalled. A final check was made between row and column totals to see that they agreed. This was called cross casting. How much easier things are today!
Cash books may have separate pages for payments and incomes, or they may all be on the same page. This is acceptable if there is only one source
of income, as in retailing. At the end of each month, thecash book is balanced and then reconciled against the bank statement. The two should agree except for timing differences. These may be due to written cheques that are uncleared, or bankings that have not been lodged.
Complications can arise in small businesses when payments have been made that are unsupported by documents or funds taken out for personal use (drawings). For this reason, all cheque payments should be recorded on the counterfoil, and all card swipe receipts saved. It gets even worse if the business uses a personal account. There is no way to reconcile the two. So what tends to happen is that undocumented expenses get lost. This is a serious problem but personal accounts may be justified if and only if, very few transactions are likely to take place.
Some smaller businesses, and all larger ones, have credit accounts with suppliers, which enables them to purchase goods now and pay later. In this case, another book is kept – purchases day book. This is driven by the document received with the supplies – the delivery note. This is recorded in
the purchases day book with the name and account number of supplier, invoice number and amount, and the suppliers account updated to record the
amount owing. When the invoice is paid, then the entry is made to the cash book, and the suppliers account updated to record that nothing more is owing.
One complication can occur when early settlement discount is taken, which means that the amount eventually paid is less than the invoiced amount. This is taken care of using a discount received account.
double entry bookkeeping
The other system – double entry bookkeeping – records each transaction twice. Each transaction is deemed to cause a credit in one account, and a debit in another account.
Double entry is normally built upon the foundations of a single entry system. That is, transactions would be recorded initially in single entry day
books and their totals posted to their respective accounts in the double entry system. The collection of accounts falls under a number of different
ledgers. Mostly, there are three ledgers – Sales (subsidiary) ledger, Purchases (subsidiary) ledger and General Ledger. The latter contains all the
accounts found in the cash book, and maps onto the expenditures and incomes of the business. The first two are used to record assets and liabilities respectively.
Double entry, though simple in concept, is difficult to get right without proper training, as knowing which accounts to debit and which to credit often causes confusion. For example, most people would be surprised to learn that a transaction that pays money into a bank account is actually posted as
a debit entry to that account in the general ledger. Keeping a double entry for most small businesses of the sort operated by sole traders, would be overkill.
A full description of the double entry bookkeeping system, is beyond the scope of these pages. However, those interested can follow this link for a