Steps in the Accounting Process

From what we have learnt till now, we may write the steps in the process of accounting as

• Recording the Journal based on the proof a transaction.
• Posting the Journal into the Ledger
• Periodically balancing the Ledger Accounts.
• Preparation of the Trail Balance.

We need a System in place before we start recording

When we are talking of the steps in the process of accounting, it is implied that there is an existing accounting system and we are talking about the journal, ledger, trial balance etc., within that system.

The accounting system is made up of all the different books of accounts and other records we maintain to help the process of accounting.

New organisation's Accounting - System Design to be done first

We need to have an existing accounting system for carrying on accounting for the transactions relating to business. Thus for a new organisation whose accounting we intend to take up, we need to design the accounting system first.

Since we are in the initial stages of learning process we have learnt the fundamental concepts wherein we learnt what a journal is and how the ledger is derived without thinking of the accounting system. One should understand that we were assuming the existence of an accounting system within which we had been recording and posting.

For a new organisation, it would not be like you start writing the journal entries and then create whatever new ledger accounts you come across or need. We design the accounting system as the first step in the process of building up an accounting system for an organisation.

List of Ledger Accounts ≡ Chart of Accounts

The first and important task in designing an accounting system is preparing the list of ledger accounts. We have to think of all the ledger accounts that are to be maintained within the organisational accounting system and prepare a list of all those account heads we need.

The list of ledger accounts is called a Chart of Accounts. This term is more popularly used in mechanised (computerised) accounting systems.

Why think about the ledger first?

Based on the dual entity concept, we can say that each accounting transaction affects two ledger accounts. The ones who are carrying on the task of accounting in the organisation identify the two ledger accounts affected by a transaction at the time of recording the transaction.

To enable systematic recording of transactions there should be consistency in such identification. Say, if expenditure on refreshments for staff is being identified as Miscellaneous expenses, there should be a consistency in such identification.

This is possible only if everyone recording the transaction has an understanding that 'Miscellaneous Expenses a/c' should be used as the ledger account affected by the transaction in such case.

This is possible only if the organisation has a list of ledger accounts and an explanation in relation thereto and makes all those who are involved with recording accounting transactions in the organisation aware of the list.

What ledger accounts are affected by a transaction is dependent on what ledger accounts are being maintained in the organisation.

What ledger accounts are being maintained in the organisation is dependent on the information needs of the organisation.

Thus, the first thing to be decided in designing an accounting system is what ledger accounts are to be maintained based on what information the organisation needs from its accounting system.

Once the organisational accounting system has been designed and is in place, only the ledger accounts (account heads) present in the chart of accounts would have to be used in recording the journal entries.

While analysing a transaction for the purpose of recording a journal entry, we identify the two accounts effected by the transaction. The two accounts we identify should be from the ones within the organisational accounting system i.e. the ones present in the list of ledger accounts.

Example

Consider office expenses like office rent, telephone charges, electricity charges, maintenance expenses incurred in an organisation.

If the organisation thinks that it does not need too much detail about all the expenses relating to the office it can use one account for all these expenses (say) by name "Office Expenses". Whenever any of these expenses is incurred, it is assumed that Office Expenses are incurred.

The elements or account heads that are affected when

• office rent is paid in cash, would be

  "Cash a/c" and "Office Expenses a/c"

• telephone charges are paid by cheque, would be

  "Bank a/c" and "Office Expenses a/c"

• ...

If the organisation thinks that it needs this information in detail, then it has to use separate ledger accounts for each of these expenses with the relevant names like "Office Rent a/c", "Office Telephone Charges a/c", "Office Electricity Charges a/c", etc.,

Whenever any of these expenses is incurred, the relevant ledger account is used.

The elements or account heads that are affected when

• office rent is paid in cash, would be

  "Cash a/c" and "Office Rent a/c"

• telephone charges are paid by cheque, would be

  "Bank a/c" and "Office Telephone Charges"

• ...

Manual Accounting

Thus where a new Account Head is being used, ensuring that the account exists in the list of ledger accounts amounts to ensuring that it has a folio in the Ledger.

In practical situations, such new account heads are incorporated in the ledger at the time the journal entry is being posted into the ledger for the first time.

A ledger account used in a journal is presumed to exist in the list

Because it is possible to use the Account head in the journal and then arrange a ledger folio, it would not be appropriate to think that any and every account head can/should be so created and used.

The organisational procedure would generally be such that an appropriate prior sanction for the use of a new account head, from those who design the accounting system, would be required for using it in a journal entry.

In using an Account head in a journal entry, we are assuming both its existence in the list of ledger accounts and its acceptance of use in that context.

In the illustrations that we have dealt with in the earlier pages we can see that there are many ledger accounts in use. We presume them to be in existence or are accepted at the time of recording the journal entries.

• Cash a/c
• Capital a/c
• Furniture a/c
• Rent Paid a/c
• Bank a/c
• Goods/Stock a/c
• M/s Ramdas & Bros. a/c
• Machinery a/c
• Mr. Natekar a/c
• Wages Paid a/c
• Commission Received a/c

Since we were in the early stages of learning accounting, we have listed the ledger accounts after writing the journal entries. That would not be the practical approach.

Mechanised/Computerised Accounting

In computerised accounting, only the Journal is prepared. The rest of the accounting process is accomplished automatically, without human intervention.

Any Accounting Head that is used while recording the journal entry would have to be pre-defined (should be in existence) in the chart of accounts of that accounting system.

This is the reason why we prepare the Chart of Accounts (list of accounting heads) to be used in the organisational accounting system as the first step in computerising the organisational accounts.

Preparation of the Journal and then the Ledger are the two steps which form part of the accounting process or cycle.

Preparation of a Trial Balance is not a part of the Accounting Cycle/Process

A trial balance is prepared to check the mathematical or arithmetic accuracy of accounting. It is a statement derived from the accounting information and is not actually a part of the accounting cycle.

We do not find any particular flow of information in the process of preparation of the trial balance. The process of preparation of the Trial Balance should not be considered a process that follows the preparation of the ledger.

A trial balance can be assumed to be an ancillary statement and the process of preparation of the trial balance, a process ancillary to the actual process of accounting.

Preparation of the Trail Balance is not the end of the accounting cycle

The trail balance is not actually a part of the accounting cycle and thus cannot terminate the process.

Accounting Process/Cycle involves other steps

We learnt that the basic purpose of accounting is derivation of information. We have also learnt that target with which the accounting process is designed is to enable collection of all the information relating to an element at a single place, which the ledger does.

Just collecting the information is not the sole objective of all accounting. The information in the ledger accounts can be put to a lot of other uses in the broad process of deriving many other pieces of information useful for an organisation. Information relating to profitability of an organisation, the position of an organisation etc., are some of these.

We will learn about them, as we move forward in the learning process. We would be able to see a lot of other information being derived based on the information in the ledger.