Does Accounting Start with writing the Journal?

• 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 of a transaction.
Posting the Journal into the Ledger
Balancing the Ledger Accounts and preparation of the Trail Balance.

» We need a System in place before we start recording

We can accept the above steps as being the steps in accounting, only within an existing accounting 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

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

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 we have to design an accounting system, which is to be understood as the first step.

It would not be like you start writing the journal entries and then create whatever new ledger accounts you come across or need.

Accounting System Design starts with preparing the list of Ledger Accounts

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

• Why think about the ledger first?

Each business transaction affects two ledger accounts. What ledger accounts are affected by the transactions 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.

The Basic purpose of accounting is derivation of information.

The more the information we need, the more the accounting heads we have to maintain.
(Or)
The more the information we need, the more the number of elements into which we have to divide the organisational accounting system

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 organisaton needs from its accounting system.

Recording a Journal Entry » Use only the Ledger Accounts within the list

Only the accounting heads present in the list of ledger accounts would be appearing in the Journal entries.
During the process of analysing a transaction, 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.
» Explanation

Consider the office expenses (rent, telephone, electricity, maintenance) being 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";

...

...

when office 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";

...

...

when office telephone charges are paid by cheque, would be "Bank a/c" and "Office Telephone Charges ".

Chart of Accounts (List of Ledger Accounts) » Where do we find it?

• Manual Accounting

In manual accounting the list of ledger accounts is only a notional idea. The list is not specifically prepared. It is assumed as a collection of the names of all the account heads in the Ledger.

Thus where a new Account Head name 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.
Appropriate prior sanction for the use by those who design the accounting system would be required for using an account head in a journal entry. In using an Account head in a journal entry, we are assuming its existence in the list of ledger accounts and its acceptance of use.
In the illustration that we have dealt with in the earlier pages we can see that there are 11 ledger accounts in use. We presume these 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 deliberately. The rest of the accounting process is accomplished automatically, without human intervention. The ledger posting happens automatically.
Any Accounting Head that is used while recording the journal entry would have to be pre-defined (should be in existence) in computerised accounting.
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.

Does accounting end with preparation of a Trial Balance

Preparation of the Journal and the Ledger are the two steps which form part of the accounting process or cycle.
• Preparation of a Trial Balance » Not a part of the Accounting Cycle/Process

A trial balance is prepared to check the mathematical/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 of preparation of the ledger.
A trial balance can be assumed to be an ancillary statement. 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 the required information.
As we move forward in the learning process, we would be able to see a lot of other information being derived all of which needs the information in the ledger.

Author Credit : The Edifier ... Continued Page 23