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Every company needs to have a bookkeeping system. Bookkeeping is the process of systematic recording, maintaining, classifying and summarising business transactions. Bookkeeping helps prepare the final financial statements and provides vital information on the cash position, profit or loss, company financial health, etc.
The transactions of a business are classified as follows:
Anything that adds value to the business is an asset of the business. The assets of a business include cash in the bank accounts, accounts receivables, equipment, inventory, furniture, computers, etc.
Anything that decreases the value of a business is a liability. The liabilities of a business are the debts owed by the business, accounts payable to the vendors, etc.
Revenue or income is the amount earned by the business through selling its products or rendering services.
The expenses are the amount spent by the business for running the business. The electric bill, salary given to the employees, utility bills, etc., are considered expenses.
The business liabilities are deducted from the business assets. The deducted sum is the equity, and it reflects the financial interest of the business.
In the single entry system of bookkeeping, all financial transactions are directly entered under the respective heads of income and expense in the cash book. The accounts are consolidated from the total amount of incomes and expenses to arrive at the business’s estimated profit or loss and final statement.
In the double-entry bookkeeping system, all the financial transactions are debited in one account and credited to another account in a journal. The journal entries are essential as they form the basis for preparing the accurate final statements of the business.
The transactions are debited and credited in the journal as per the rules of the following three accounts:
The assets and liabilities come under the real accounts. The assets are debited, and liabilities are credited. The rule of the transactions recorded under the real accounts is – debit what comes in and credit what goes out.
Under the personal accounts, the transactions with natural or artificial persons like individuals, firms, companies and associations are recorded. The rule of the personal account is – debit the receiver and credit the giver.
All the incomes, expenses, losses and gains are recorded under the nominal account. The nominal account rule is – debit all the incomes and gains and credit all the expenses and losses.
The basic principle of bookkeeping is to record the financial transactions of business on a day-to-day basis. The bookkeeping principles ensure that all financial transactions are comprehensive, up to date and provide the information required for preparing the accounts. The following are the principles of bookkeeping:
The revenue principle states at what time the bookkeeper can record a transaction as revenue in the books of account. As per the principle, a transaction is recorded as revenue earned for the business at the time of point of sale.
The revenue principle states that the revenue occurs at the time when the business/buyer takes legal possession of the item/goods sold or when the service is performed. It implies that revenue occurs for the business when the goods are received, or the services are performed irrespective of the time of payment for the transaction to the seller. This concept is also known as the revenue recognition principle.
The expense principle states the point of time at which the bookkeeper can record a transaction as an expense in the books of account. The expense of a business occurs at the time when it accepts the goods or services from another entity/seller. It implies that the expenses occur when the goods are received, related or service is performed, irrespective of when the bills or payments are made for the transaction.
The matching principle states that when the bookkeeper records the revenues, all the related expenses must also be recorded at the same time. Thus, the inventory is charged to the cost of the goods sold at the same time that the revenue from the sale of the inventory items is recorded.
The cost principle states the historical cost of an item should be used in the books of accounts and not the resell cost. For example – If a business owns property or vehicle, these assets should be recorded at their historical costs and not the current fair market value of the property.
The objective principle states that the bookkeeper should use only factual and verifiable data in the books of accounts and not the subjective measurement of values. Even when the subjective data appears better than the verifiable data, only the verifiable data must always be used.
The journals are an essential part of the bookkeeping system. The complete information about a transaction can be found in the journals. The general journal is used by many businesses to record the debit and credit amounts of each transaction that occur under the double-entry bookkeeping system. It may also state a short description of the transactions.
The ledger groups the transactions of a business as per the account and its effect on the business. Such categories or grouping in the ledger include liabilities, assets, revenue and expenses. The business transactions from the journals are recorded or posted to the ledgers periodically. The financial position of the business can be ascertained with the help of the ledgers.
The financial statements state the information about the financial situation of a business/company to the outside parties. Most bookkeeping systems use the following four main financial statements: