What is BookKeeping?
Bookkeeping is the day to day recording of the company’s financial transactions such as purchase, sales, receipts and payments and forms an initial part of the accounting process. It can be prepared in two ways – Single entry systemSingle Entry SystemThe Single Entry System is an accounting approach under which every accounting transaction is recorded with only a single entry towards the results of the business enterprise, shown in the statement of income of the company. and Double-entry systemDouble-entry SystemDouble Entry Accounting System is an accounting approach which states that each & every business transaction is recorded in at least 2 accounts, i.e., a Debit & a Credit. Furthermore, the number of transactions entered as the debits must be equivalent to that of the credits. , however, the double-entry system is popular and recognized in most of the countries.
Components of Bookkeeping in Accounting
#1 – Cash vs. Accrual Method
In Cash basis of beekeeping, income and expenses are recorded only when cash is received, and expenses are paid from the bank, respectively. The cash method fails to consider the matching and periodicity concept, which says that the expenses of one period should be recognized in the same period. Accrual method, on the other hand, takes income and expenses into account as soon as it becomes due. It means that once income is earned, it is recognized in the books as receivable, and once we have billed for expenses, we recognize it in the books. The accrual method is widely accepted used for bookkeeping across the globe.
#2 – Chart of Accounts
Chart of accountsChart Of AccountsChart of Accounts (COA) is a list of all the accounts in which a business records its regular operational expenses. It is used to collect information for preparing a Company’s financial statements. is a detailed worksheet which contains guideline and framework that what kind of expense should go to which general ledger account. It helps a bookkeeper to pick up the correct expense code while posting any journal entry. Chart of accounts are kept up to date and reviewed periodically to include any changes in the organization.
#3 – Journals
Journal entries record the financial impact of any transaction of a business entity, and this is the first step of recording any transaction. Before posting a journal entry, we must understand the golden rules and fact that every business transactionBusiness TransactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements. is recorded in two different accounts, a debit and a credit. The journals are posted based on rules which are following –
- For Real Accounts: Debit what comes in Credit what goes out.
- For Personal Accounts: Debit the receiver Credit the giver.
- For Nominal Accounts: Debit all expenses & losses and Credit all income & gains.
- Real Accounts: Real accountsReal AccountsReal accounts do not close their balances at the end of the financial year but retain and carry forward their closing balance from one accounting year to another. In other words, the closing balance of these accounts in one accounting year becomes the opening balance of the succeeding accounting year. are the balance sheet accounts of which include assets (Cash, Furniture, Building, etc.) and liabilities (accounts payable, notes payable, etc.).
- Personal Accounts: All the accounts related to individuals, firms, companies, etc. fall under Personal counts. It includes debtors, creditors, banks, outstanding and prepaid items, etc.
- Nominal Accounts: The accounts related gains, losses, expenses or incomes fall under Nominal accountsNominal AccountsNominal Accounts are the general ledger accounts which are closed by the end of an accounting period. Their balance at the end of period comes to zero so they don't appear in the balance sheet.. Eg. – Purchase, sales, bills paid, interest received, bank charges, etc.
#4 – Ledgers
A ledgerLedgerLedger in Accounting, also called the Second Book of Entry, is a book that summarizes all the journal entries in the form of debits & credits to use for future reference & create financial statements. is the primary books of accounts which shows the debit and credit transactions related to one account for a particular period in a summarized format. It also shows the opening balance and closing balances of that account after taking into consideration all the debit and credit transactions for a given period. Once the financial period is over, the ledger balanceLedger BalanceA ledger balance is an opening balance that remains available during the start of each business day. It comprises of all the deposits and withdrawals, used in the calculation of the total funds left in an account at the end of the previous day. is transferred to trial balance, which is used for preparing further financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels..
#5 – Day Books
Daybooks are used to record the credit transaction separately. A sales day bookSales Day BookA sales day book is a manual ledger providing elaborative information on credit sale made by a salesperson to the customer and documents the customer name, invoice number, date and amount of invoice. records all the credit salesThe Credit SalesCredit Sales is a transaction type in which the customers/buyers are allowed to pay up for the bought item later on instead of paying at the exact time of purchase. It gives them the required time to collect money & make the payment. , and in the same way, purchase daybook records all the credit sales. Purchase return and sales return books are also prepared to keep track of all the returns from credit purchase and sales.
#6 – Cash Book
Cashbook is also one of the primary books of accounts which are maintained by almost all businesses and person. Cashbook shows opening balance, which is cash in hand available at the start of the financial period, all the cash/bank related transactions involving cash/bank during the financial period and closing balance, which is cash in hand available after the financial period is over.
#7 – Financial Statements
Once journals are posted, ledgers, daybooks, and cash book are prepared, these balances are transferred to trial balance which is a summary of all account showing their net balances. Trial balance is further used to prepare a profit & loss account and balance sheet. Profit & Loss shows the net result of whether the business made any profit or not. The balance sheet is the statement showing a summary of all assets and liabilities.
- Simplified process and easy steps for recording transactions;
- Makes usage and comparison of financial statements easier.
- The primary books and data input in the bookkeeping system are used higher management for decision making and critical analysis.
- This system provides all the payrollPayrollPayroll refers to the overall compensation payable by any organization to its employees on a certain date for a specific period of services they have provided in the entity. This total net pay comprises salary, wages, bonus, commission, deduction, perquisites, and other benefits. details and deductions made.
- The tracking of expenses and budget is easier in a sound bookkeeping system.
- Easier to extract data for audits.
- A separate bookkeeper is needed, which costs time and money.
- If the wrong data feeds into primary books of accounts, it leads to error in the preparation of trial balance and final accounts.
Points to Note about Changes
Bookkeeping is the first stage and an essential part of the accounting process of any organization. When implemented carefully, a sound system will help in accurately preparing financial statements on time, which will lead to timely tax filings and smooth audit facilitation. Also, the data extracted from bookkeeping entries helps in making complex reports, which helps management in decision making. It also helps in creditors and debtor management and updated ledger balances of all accounts, so we can conclude that a sound system enables a business to run smoothly and helps with all sorts of data input for further analysis.
This article has been a guide to the basics of bookkeeping and its definition. Here we discuss components of bookkeeping in accounting along with advantages and disadvantages. You can learn more about financing from the following articles –