Accounting System

Updated on April 10, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Accounting System Definition

The accounting system is what a company employs to record and manage its financial or accounting records, including income and expenses. It is guided by a set of accounting guidelines and procedures that help generate accurate financial documents, which are a ready reference for internal and external stakeholders to make effective business and investment decisions.

What is an accounting system

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The system is broadly classified into two categories – single entry and double entry. No matter which version a firm uses, it is a significant tool to track the performance of a business and accordingly help organizations plan different strategies for effective results.

Key Takeaways

  • An accounting system refers to the financial reporting mechanism where every transaction is recorded to prepare financial statements to be checked and validated by internal and external stakeholders.
  • The decision-making is done based on the data represented in this system. Hence, the accuracy of this system determines how effective those business decisions would be for the organization. 
  • Single entry and double entry systems are two types.
  • Today, record keeping has become fully computerized with the use of accounting software that saves users time, effort, and money.

How Accounting System Works?

An accounting system helps organizations maintain their accounts and record all the incoming and outgoing resources. As a result, they can track how much is being earned and what’s being spent. In short, when companies use an organized system of accounting, it enables them to track their performance from a financial point of view.

When companies record transactions properly, the documents prepared are accurate and they act as a ready reference for businesses whenever they need to retrieve or check any particular transaction for a particular period. This account-keeping system, however, includes details about purchases, sales, and liabilities recorded as expenses, income and expenses, and funding and accounts payable

As the data set is crystal clear, the details can be well represented via graphs and charts, providing a better comparative structure for businesses to assess. As a result, decision-making is more efficient and accurate.

Whenever a transaction, such as sales, purchase, expense, etc., occurs, it is recorded through proper journals, becoming the first entry in the system. As companies use the computerized accounting systems nowadays, the automated mechanism makes the respective entries in the correct account’s ledger whenever users post a journal.

At the end of the period, however, it calculates the balance of each ledger and prepares different financial statements like balance sheets, cash flows, etc. Therefore, generating reports to refer to becomes easier, while assisting the management to make important financial decisions.

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Types

Furthermore, the accounting system that companies use to record the transactions and prepare financial documents for financial reporting over a period can be classified into two broad categories – single entry system and double entry system.

Types of Accounting System

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A single-entry accounting system is one that records only expense or income. This is the traditional form of maintaining financial records. It is called a single entry accounting system as the entries are made only once to simultaneously reflect the expense and income. Thus, small organizations prefer this system as they do not deal with huge inflow or outflow of resources. However, due to the incomplete and unclear data, the tax authorities do not recognize this kind of recordkeeping for financial reporting.

On the contrary, users consider the double entry accounting system as more accurate, and the tax authorities recognize them. In the process, whenever a transaction occurs, it affects two different accounts at a time. This means that when there is an inflow, it is both income and asset, while if there is an outflow, it is both expense and liability. Here, the data is crystal clear. Hence, the preparation of graphs and charts is easier for reliable financial reporting.

Components

The accounting system is of no use if users do not have the components that help facilitate the process. Earlier, users operated the entire system manually. Hence, accounting executives and management had to check large registers, accounting books, etc., before making minor/major business decisions. 

Accounting System Components

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The major components of the conventional method are expenses, funding, invoices, etc. Thus, from the cash flows to preparing the balance sheet and other financial documents, this system utilizes the information gathered in various categories, constituting its components. These include accounts payable, accounts receivable, billings, fixed assets, payroll, and inventory.

Today, when everything is computerized and automated, the number of components has increased. Of course, the data required remains the same, but there is a software-driven infrastructure that supports the whole process. These include source documents, input devices, storage capacity, processors, and output devices.

Examples

As we proceed further, let us consider the following examples to understand how the accounting system works:

Example 1

Retailers buy and sell goods. So, their accounting system should concentrate on the inventory level and discounts they give or receive on each product. Thus, the whole system should be based on different products and their payable or receivable. It should help them with ratios like gross profit margin, net profit margin, and other required measures in their operation.

Example 2

The most crucial factor in the construction industry is the cost of material. Therefore, the system should be more elaborated on different types of raw material inputs and be able to retrieve different ratios, which shows the movement of cost.

Advantages & Disadvantages

As accounting systems are becoming computerized, things are smoother and more effective for businesses. However, these systems are not devoid of disadvantages. So, let us have a quick look at the pros and cons of the online accounting system:

ProsCons
Saves time and moneyComputerized system has some challenges
Reduces errorsChange in programs required to prevent bugs and programming errors
Provides a better view of the financial data 
Improves management of cash flows 
Makes filing tax returns easier 

Frequently Asked Questions (FAQs)

What is the basic accounting system?

It is implemented by companies to record financial information, including income, expenses, and other accounting transactions. It is an important tool that monitors and tracks the company’s performance and ensures the smooth running of the business.

What is a cost accounting system used for?

It refers to the accounting mechanism that helps assess a company’s total cost of production, keeping into account the variable and fixed costs involved in each stage of production. It helps the management predict the cost and selling prices of a product and accordingly make effective business decisions.

What is a computerized accounting system?

A computerized system, like Xero accounting system, is an information system mechanism that processes transactions and events based on the Generally Accepted Accounting Principles (GAAP). This, in turn, helps organizations generate reports and assess different aspects of a company’s finances per their requirements.

This is a guide to what is Accounting System. Here we explain its traditional & computerized versions along with its types, features and examples. You can learn more from the following articles-

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