How the Accounting Process Works

First you Collect the accounting information from data sources available.

Once the information is identified, it is posted to the books of prime entry.

These are not double entry and are just lists: sales day book, sales day returns book, purchases day book, purchases returns book, cash book, petty cash book and the journal (includes all other types of items that do not fall into the other books)

The books of prime entry are then entered into the ledger accounts which may be of any number and are in double entry format. e.g. purchase of car for cash will Dr. motor account Cr cash account

The collection of ledger accounts is known as the general ledger or nominal ledger

Separately business entities will maintain lists of individual receivables and payables due from each customer and supplier. These will be known as memorandum balances often referred to also as receivables ledger and payables ledger. These are not to be confused with the receivables and payables ledger control accounts. The memorandum ledgers are also sometimes known as subsidiary ledgers or individual ledgers. They are not part of the double entry system.

The receivables and payables control accounts are part of the double entry system and the general ledger unlike the memorandum (which is not part of the ledger either).

Errors that are NOT revealed by the Trial Balance

The trial balance is a list of all the general ledger balances. Each ledger account part of the general ledger will have either a debit or credit balance. Since the general ledger entries are all double entries, it follows that the resulting balances should also balance.

The trial balance is essentially a control system that helps identify and evaluate errors made. There are however limitations. The following are the types of errors that are not revealed by the trial balance:

1. Error of Omission: no entry at all in a case when there should have been
2. Error of Commission: entry to the wrong individual account. 
3. Error of Principle: entry to the wrong type of account e.g. $100 posted to assets instead of purchases. (both are debit entries)
4. Error of Original Entry: wrong amounts are posted to both credit and debit
5. Error of Reversal: correct amounts are posted to the correct accounts but on the wrong sides
6. Error of Transposition: posting $123 instead of $321 on both sides
7. Compensating errors: two or more erros that compensate each other

The trial balance can still be a useful accounting control system however. The following mistakes are revealed:

1. Posting to one side only
2. Posting both entries to one side only
3. Posting different figures to each side
4. An individual account added up incorrectly
5. Opening balance not brought down
6. Balance in the trial balance is different from balance on the account (extraction error)

Business Entity Types - Need to Know

There are three types of business entity types to worry about in accounting: sole trader, partnership and limited liability company. 

The following are the characteristics of each one:

1. Sole Trader

• Operated by only one individual although it may employ any number of people (only one owner!)
• No legal distinction between owner and entity so the owner is liable for any litigation claims or taxes personally (unlimited liability for debts and losses)
• The equity part of the capital structure is represented by the capital account which is increased when new capital is contributed by the owner or profits are generated by the entity and reduced by losses of the entity and any withdrawals, typically referred to as "drawings" rather than dividends. 
• In some countries drawings by the owner may not be subject to income tax or dividend tax making this type of entity more appealling for small enterprises. Sole trader entities in many countries may have simplified accounting and not be subject to audit requirements. 

2. Partnership

• More than one partner
• Unlimited liability to the partners for debts and losses
• Equity capital section consists of two accounts: capital account and current account
• Capital account is normally fixed and is adjusted when partners join and leave 
• Current account incorporates the earnings of the business that are earned less any drawings by the partners. 

3. Limited liability companies

• established as separate legal entities to their owners so shareholders are not liable for the legal entity debts
• common shareholders have a claim on the residual assets of the limited liability company
• managed by the directors of the entity which may or may not be shareholders
• if the shareholders are not involved in the business, their insolvency or death will not affect the limited liability company they own. 
• limited liability companies may be subject to increased regulatory requirements such as production and submission of audited financials, public inspection of accounts
• limited liability companies are separately taxed to its owners

ACCA Financial Accounting Terms Worth Knowing (FA Glossary)

Discount received - should be a Cr as it is effective income on the P&L. This is the case when the supplier decides to offer a discount to the business.

Discount allowed - same as a a sales discount. It is debited as a reduction in sales.

Dishonoured Cheques - presented by the customer/client but failed to generate cash for the business. They must therefore be credited on the cash book to reverse the previous booking of cash receipts on the debit side when it was originally presented.

Unpresented Cheques - cheques issued by the business but not banked by the recepient. Therefore the cash book credited by this amount.

Invoice - document issued by the supplier to the customer, identifying the details for the transaction such as price, taxes, quantity, name of each counterparty. The document represents an asset to the supplier based on which the customer owes money to the suppier.

Purchase Order - written authorization from the buyer issued to the seller to acquire goods or services. The purchase order will price, quantity and other material parameters such as quality and delivery conditions.

Delivery Note - document accompanying the shipment of goods specifying description and quantity

Lodgement - act of paying into a bank account

Drawings - withdrawals of cash by the owners of the business from the business

Sales Returns = Returns Inwards

Purchase Returns = Returns Outwards

General Ledger aka Nominal Ledger - a list of all credit and debit transactions with details on each

Trial Balance - a list of all credit and debit ending balances in one table in double entry format. Auditors will start with the trial balance but will use the general ledger to trace any errors in it.

Drawings - in a partnership this is an account separate from the capital account which covers the funds withdrawn by the partners from the business

Imprest System (Imprest Amount) - petty cash management system involving a float which is regularly topped up to a certain level of funds called the imprest amount which is normally sufficient to cover the expected cash needs over the period

A/R ledger control account (not to be confused with the A/R ledger account)

A/R ledger account (Memorandum) - this is a separate list of individual Accounts Receivables for each counter party

Books of Prime Entry: (list-format books) include sales day book, sales returns day book, purchases day book, purchase returns day book, cash book, petty cash book, journal (all other transactions)

Ledger accounts - double entry accounts such as e.g. plant account