Professional Documents
Culture Documents
accounting system
For the purposes of the FA1, FA2 and FFA/FA exams, it is assumed that every entity
uses a computerised accounting system and that the sales and purchases systems are
integrated into the accounting system.
This means that the sales and purchases are not recorded on a separate system and
then manually input to the accounting system. Instead, whenever an entity recognises a
sale or a purchase, various records will be automatically updated, simultaneously. In
this article, we will explore a simple sale/purchase transaction and consider how the
accounting records would be updated for each entity in the transaction.
For the purposes of this article, we will ignore sales tax and any brought forward
balances that may exist due to trading in the prior year. We will also not consider how
the ledger accounts are ‘balanced off’ and will, instead, focus on the initial recording of
the sale/purchase and subsequent receipt/payment.
In this scenario, Farida is a sole trader who designs and manufactures accessories for
pets. These include products such as collars, feeding bowls, toys and harnesses.
Farida does not sell to the public but, instead, she sells her products exclusively to other
businesses such as pet shops and supermarkets.
Pierre is another sole trader. He runs a small pet shop and is one of Farida’s regular
customers.
On 1 January 20X1, Pierre used Farida’s website to place an order for 100 dog collars
at a cost of $5 per collar. This is Farida’s first sale of the new year but Pierre has been a
longstanding customer and she allows him credit terms of 60 days.
First, we will consider the transaction from Farida’s perspective and the impact on her
entity’s accounting records before we consider how Pierre would record the purchase
for his entity.
The sale – Farida’s accounting records
When Farida received the order, she arranged for the goods to be posted for same-day
delivery along with a delivery note which included the number of collars ordered, the
date of the delivery and the address which Pierre had requested the goods be sent to.
Once the delivery was made and Pierre received the goods, Farida generated a sales
invoice in her accounting system to request payment from Pierre. Through generating
the sales invoice, Farida’s accounting system did two things:
1. Produced a sales invoice in a format which Farida could then email or post to
Pierre; and
2. Updated the accounting records to reflect that the sale to Pierre had been made
and amounts were now due from him
1. The sales invoice
The sales invoice that Farida created may have looked something like this:
Subtotal $500.00
Sales tax $0.00
TOTAL DUE $500.00
2. The accounting records
On generating the sales invoice, Farida’s accounting system will have automatically
updated her accounting records to reflect that a sale was made to Pierre. The records
which will have been updated are:
To update the general ledger, the following journal entry will have been recorded (by the
system) on the issue of the invoice:
This would have the effect of updating each ledger account as follows:
$ $
Revenue 500
This represents a debit balance of $500 in trade receivables as a result of the sale to
Pierre.
$ $
Of course, although this is her first sale of the year, Farida will expect to make other
sales – some of which may be to Pierre but many will be to other customers.
As Farida makes more sales, the trade receivables and revenue ledger accounts will be
updated so that they will not only include sales made to Pierre but the total sales made
throughout the year and the total amounts owed by all credit customers.
Therefore, so that Farida knows how much money Pierre owes her and what
transactions have been made with him individually, his individual customer account will
be updated automatically at the same time as the general ledger accounts are updated:
20X1 $ 20X1 $
1 January 500
Each customer will have a separate customer account which lists out all of the individual
transactions with that particular customer. These records are sometimes referred to as
‘subsidiary ledgers’ because they are separate to the main general ledger accounts
where the double-entry bookkeeping takes place and which include transactions and
balances related to every customer in aggregate.
It is extremely important that Farida keeps an accurate record of her revenue and trade
receivables so that she knows the total sales she has made and the total amounts owed
to her by all of her customers. However, it is equally important that she separately
tracks how much each of her individual customers owes her – otherwise she will not be
able to accurately manage her cash flow or may not be aware of any customers who
are at risk of late payment.
As well as being updated for any sales made, the trade receivables account in the
general ledger and the relevant individual customer account will also be reduced when
customers send their payments.
For instance, if Pierre were to pay for the goods on 15 January 20X1, Farida would
record the receipt in her accounting system and will be able to match the receipt to the
sales invoice, indicating that the receipt was from Pierre. This will cause her general
ledger to be updated (automatically) with the following journal entry:
Dr Bank $500
Cr Trade receivables $500
$ $
There is now a credit of $500 in the trade receivables ledger account referenced to
‘Bank’, which indicates that there has been a receipt from a credit customer. As the
debits are now equal to the credits, this means that trade receivables is effectively
showing a nil balance due from all customers.
$ $
The bank account in the general ledger now shows a $500 debit balance referenced to
trade receivables, representing a positive cash balance due to a receipt from a credit
customer.
As well as updating the general ledger accounts, Pierre’s individual customer account
will be updated simultaneously and will now show that he has no debts outstanding:
20X1 $ 20X1 $
From Farida’s perspective, this transaction was a sale. However, from Pierre’s
perspective, this was a purchase of goods.
For the purposes of this article, we will assume that Pierre did not record any entries in
the accounting system until he received the sales invoice from Farida. From Pierre’s
perspective, the sales invoice issued by Farida would be referred to as a ‘purchase
invoice’ as this is how it will be classed in his own accounting records. However, it is in
fact the same document as issued by Farida.
In the same way that Farida’s accounting entries updated her general ledger accounts
and Pierre’s individual customer account, Pierre’s accounting entries will update his own
general ledger accounts and Farida’s individual supplier account. The individual supplier
accounts are records for each of Pierre’s suppliers so that he can track and manage
amounts owing to each supplier and work in a similar manner to the individual customer
accounts.
When entering the details from the purchase invoice received (i.e., the sales invoice that
Farida sent) into the accounting system, Pierre will include the fact that this was a
purchase from Farida. This will mean that the accounting system will update the general
ledger and Farida’s individual supplier account automatically.
The general ledger accounts which will be updated are purchases and trade payables,
with the following journal entry:
Dr Purchases $500
Cr Trade payables $500
$ $
Purchases 500
$ $
These are effectively a mirror image of Farida’s accounting entries. Instead of a debit
balance in trade receivables and a credit balance in revenue, Pierre’s accounting
records will show a debit balance in purchases and a credit balance in trade payables.
Farida’s individual supplier account will be updated simultaneously and will now show
that he has an obligation to pay Farida $500:
F8421 – Farida
20X1 $ 20X1 $
1 January 500
The reference ‘F8421’ is the account number allocated to Farida’s individual supplier
account in Pierre’s accounting system. Businesses will choose their own referencing
system for customers and suppliers to help them track individual transactions.
Once Pierre makes the payment to Farida, he will update his accounting records so that
the general ledger and Farida’s individual supplier account are updated to reflect the
payment made:
$ $
$ $
When making this entry in the accounting system, Pierre will also ensure that he utilises
the functionality of his accounting system so that the payment is allocated against
Farida’s individual supplier account:
F8421 – Farida
20X1 $ 20X1 $
Now Pierre’s accounting records will still show total purchases of $500 but no amounts
owed to Farida or any other suppliers.
Summary
In this article, we have used a very simple scenario and have not considered in detail all
the events which may occur in real life. For example, we have not considered when
goods are subject to sales tax, if some goods are returned to the supplier or the impact
on accounting records if further purchases are made or goods are not paid for in full.
However, these are simply a continuation of the principles presented in this article and
will be further developed over the course of your studies.