CHAPTER 4

ACCOUNTING SYSTEMS
DEFINITION
 An accounting system is the methods and procedures for collecting, classifying,
summarizing, and reporting a business’s financial and operating information.
 It consists of the business documents, journals, ledgers, procedures, and internal
controls needed to produce reliable financial statements and other accounting reports.
 It ranges from simple to sophisticated system.
Simple system - In which accounting records are maintained by hand ---
manual accounting sytem.
Sophisticated system - In which accounting records are maintained
electronically --- computerized (computer-
based) system.
 The accounting system to be used in any given company should be especially tailored
to the size and to the information needs of the business.
PRINCIPLES OF ACCOUNTING SYSTEMS
To have an efficient and effective accounting system, certain basic principles must be
followed. These principles are:
 Cost awareness – an accounting system must be cost effective. Benefits of
information must outweigh the cost of providing it.
 Useful output – to be useful, information must be understandable, relevant, reliable,
and accurate. Designers of accounting systems must consider the needs and
knowledge of various users.
 Flexibility – an accounting system should accommodate a variety of users and
changing informational needs. The system should be sufficiently flexible to meet the
resulting changes in the demands made upon it.
 Adequate internal controls – an accounting system should aid management in
controlling operations.
 Adaptation to organizational structure – an accounting system must be tailored to
the organizational structure of a business.
If an accounting system meets the above principles, it can provide a valuable service to
both individual and organizational needs.

DEVELOPING AN ACCOUNTING SYSTEM

Developing an accounting system involves the following four phases:
 Analysis – planning and identifying information needs and sources.

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 Design – creating forms, documents, procedures, job descriptions, and reports.
 Implementation – installing the system, training personnel, and making the system
wholly operational.
 Follow-up – evaluating and monitoring effectiveness and efficiency and correcting
any weaknesses.
These phases, which represent the life cycle of an accounting system, suggest that few
systems remain the same forever. As experience and knowledge are obtained, and as
technological and organizational changes occur, the accounting system may also have to
grow and change.

INTERNAL CONTROL
Internal control consists of the policies and procedures used to safeguard a company’s
assets and to ensure that reliable financial statements are the end result of an efficient
accounting system.

Objectives of Internal Control

Internal control provides reasonable assurance that:
1. Assets are safeguarded and used for business purposes.
2. Business information is accurate.
3. Employees comply with laws and regulations.

Elements of Internal Control

How does management achieve its internal control objectives? Management is
responsible for designing and applying five elements of internal control to meet the
three internal control objectives. These elements are: The control environment, Risk
assessment, Control procedures, Monitoring, and Information and communication.

1. The control environment

A business’s control environment is the overall attitude of management and employees
about the importance of controls. The factors that influence the control environment are:
 Management’s philosophy and operating style.
 Organizational structure.
 Personnel policies.
2. Risk assessment
All organizations face risks. Management should assess these risks and take necessary
actions to control them, so that the objectives of internal control can be achieved.

3. Control procedures

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Control procedures are those policies and procedures that management has established
within the control environment in order to provide reasonable assurance that enterprise
goals will be achieved.
Control procedures can be divided into three types: Personnel controls, Records controls,
and Checks and balances

Personnel controls
 Employee competence
 Assignment of responsibility
 Division of work
 Rotation of duties
Records controls
 Custodianship
 Adequate records
 Documentation
Checks and balances
 Reconciliation
 Internal auditing
 External auditing

4. Monitoring
Monitoring the internal control system locates weaknesses and improves control
effectiveness.

5. Information and communication

Information about the control environment, risk assessment, control procedures, and
monitoring are needed by management to guide operations and ensure compliance with
reporting, legal, and regulatory requirements.
SPECIAL JOURNALS AND SUBSIDIARY LEDGERS

 In the preceding chapters, all transactions were initially recorded in a two-column

journal (general journal), then posted to the appropriate accounts in the ledger
(general ledger).

 Applying such detailed procedures to a large number of transactions that are often
repeated is impractical.

 Rather, as the number of transactions increases, companies must develop more

efficient ways of recording transactions.

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Expanding the General Journal - Special Journals

 Most transactions can be classified into one of a few major groups.

 For each of these groups, a special journal is designed as the book of original entry.
The four most common special journals in a merchandising company are:

1. Sales journal – all sales of merchandise on account.

2. Cash receipts journal – receipt of cash from any source.

3. Purchases journal – all purchases of merchandise or other items on account.

4. Cash payments journal – payments of cash for any purpose.

 If a transaction cannot be recorded in a special journal, it is recorded in the general

journal.

Expanding the General Ledger - Subsidiary Ledgers

 As the number of purchases and sales on account increase, the need for maintaining a
separate account for each creditor and debtor is clear.

 If such accounts are numerous, their inclusion in the general ledger with all other
accounts would cause the ledger to become unmanageable.

 When there are a large number of individual accounts with a common characteristic,
it is common to place them in a separate ledger called a subsidiary ledger.

 The individual accounts with creditors are arranged in alphabetical order in a

subsidiary ledger called the accounts payable ledger or creditors ledger.

 The related controlling account in the general ledger is Accounts Payable.

 The individual accounts with credit customers are arranged in alphabetical order in a
subsidiary ledger called the accounts receivable ledger or customers ledger.

 The related controlling account in the general ledger is Accounts Receivable.