Chapter 5: Accounting Systems

An accounting system is the methods and procedures for collecting, classifying, summarizing,
and reporting a business’s financial and operating information. Most accounting systems,
however, are more complex. As a business grows and changes, its accounting system also
changes in a three-step process. This three-step process is as follows:
Step 1: Analyze user information needs.
Step 2: Design the system to meet the user needs. Step
3: Implement the system.

Once a system has been implemented, feedback, or input, from users is used to analyze and
improve the system. Internal controls and information processing methods are essential in an
accounting system. Internal controls are the policies and procedures that protect assets from
misuse, ensure that business information is accurate, and ensure that laws and regulations are
being followed.

Processing methods are the means by which the system collects, summarizes, and reports
accounting information. These methods may be either manual or computerized. In the following
sections, manual accounting systems that use special journals and subsidiary ledgers are
described and illustrated. This is followed by a discussion of computerized accounting systems.

5.1. Manual and Computerized Accounting Systems

Manual Accounting Systems

Accounting systems are manual or computerized. Understanding a manual accounting system is
useful in identifying relationships between accounting data and reports. Also, most computerized
systems use principles from manual systems. In prior chapters, the transactions were manually
recorded in an all-purpose (two-column) journal. The journal entries were then posted
individually to the accounts in the ledger. Such a system is simple to use and easy to understand
when there are a small number of transactions. However, when a business has a large number of
similar transactions, using an all-purpose journal is inefficient and impractical.

For example, in a given day, a company might earn fees on account from 20 customers.
Recording each fee earned by debiting Accounts Receivable and crediting Fees Earned would be
inefficient. Also, a record of the amount each customer owes must be kept. In such cases,
subsidiary ledgers and special journals are useful.

5.2. Subsidiary Ledgers and Controlling Accounts

Subsidiary Ledgers: An accounting system should be designed to provide information on the
amounts due from various customers (accounts receivable) and amounts owed to various
creditors (accounts payable). A separate account for each customer and creditor could be added
to the ledger. However, as the number of customers and creditors increases, the ledger would
become awkward (difficult to handle or manage).

A large number of individual accounts with a common characteristic can be grouped together in a
separate ledger called a subsidiary ledger. The primary ledger, which contains all of the balance
sheet and income statement accounts, is then called the general ledger. Each subsidiary ledger is

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represented in the general ledger by a summarizing account, called a controlling account. The
sum of the balances of the accounts in a subsidiary ledger must equal the balance of the related
controlling account. Thus, a subsidiary ledger is a secondary ledger that supports a controlling
account in the general ledger.

Two of the most common subsidiary ledgers are as follows:

Accounts receivable subsidiary ledger
Accounts payable subsidiary ledger

The accounts receivable subsidiary ledger, or customers ledger, lists the individual customer
accounts in alphabetical order. The controlling account in the general ledger that summarizes the
debits and credits to the individual customer accounts is Accounts Receivable.

The accounts payable subsidiary ledger, or creditors ledger, lists individual creditor accounts in
alphabetical order. The related controlling account in the general ledger is Accounts Payable.
The relationship between the general ledger and the accounts receivable and accounts payable
subsidiary ledgers is illustrated below:

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5.3. Special Journals
Special journals are a method of summarizing transactions. One method of processing data more
efficiently in a manual accounting system is to expand the all-purpose two-column journal to a
multicolumn journal. Each column in a multicolumn journal is used only for recording
transactions that affect a certain account. For example, a special column could be used only for
recording debits to the cash account. Likewise, another special column could be used only for
recording credits to the cash account. The addition of the two special columns would eliminate
the writing of Cash in the journal for every receipt and every payment of cash. Also, there would
be no need to post each individual debit and credit to the cash account. Instead, the Cash Dr. and
Cash Cr. columns could be totaled periodically and only the totals posted. In a similar way,
special columns could be added for recording credits to Fees Earned, debits and credits to
Accounts Receivable and Accounts Payable, and for other entries that are repeated.

An all-purpose multicolumn journal may be adequate for a small business that has many
transactions of a similar nature. However, a journal that has many columns for recording many
different types of transactions is impractical for larger businesses. The next logical extension of
the accounting system is to replace the single multi-column journal with several special journals.
Each special journal is designed to be used for recording a single kind of transaction that occurs
frequently. For example, since most businesses have many transactions in which cash is paid out,
they will likely use a special journal for recording cash payments. Likewise, they will use
another special journal for recording cash receipts. Special journals are a method of summarizing
transactions, which is a basic feature of any accounting system.

The format and number of special journals that a business uses depends on the nature of the
business. A business that gives credit might use a special journal designed for recording only
revenue from services provided on credit. In contrast, a business that does not give credit would
have no need for such a journal. The transactions that occur most often in a small service
business and the special journals in which they are recorded are as follows:

The all-purpose two-column journal, called the general journal or simply the journal, can be used
for entries that do not fit into any of the special journals. For example, adjusting and closing
entries are recorded in the general journal. The following types of transactions, special journals,
and subsidiary ledgers are described and illustrated:

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As shown above, transactions that are recorded in the revenue and cash receipts journals will
affect the accounts receivable subsidiary ledger. Likewise, transactions that are recorded in the
purchases and cash payments journals will affect the accounts payable subsidiary ledger.

Computerized Accounting Systems

Computerized accounting systems are widely used by even the smallest of companies.
Computerized accounting systems have the following three main advantages over manual
systems:
Computerized systems simplify the record-keeping process in that transactions are recorded
in electronic forms and, at the same time, posted electronically to general and subsidiary
ledger accounts.
Computerized systems are generally more accurate than manual systems.
Computerized systems provide management with current account balance information to
support decision making, since account balances are posted as the trans-actions occur.

The computer does not make journalizing, posting, and mathematical errors. For example, a
computerized accounting system will not process a transaction unless the total debits for the
transaction equal the total credits for a transaction. Instead, an error screen will notify the user
that the transaction data must be corrected. Likewise, the computer will not make posting or
mathematical errors.

The discovery and correction of errors, however, is important in a computerized system. Errors
that can occur in a computerized system include the following:
Failing to record a transaction.
Recording a transaction more than once.
Recording a transaction in incorrect accounts.
Entering an incorrect number in both the debit and credit parts of the transaction.

The preceding errors are often discovered by reviewing the computerized trial balance for any
account balances that are unusual or unreasonable. For example, a credit balance for Supplies
indicates that an error has occurred. In addition, errors are often discovered when parties affected
by the incorrect transaction complain. For example, an employee would likely complain about a
missed or incorrect payroll check.

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Incorrectly recorded transactions can be corrected in computerized accounting systems by
deleting the incorrect entries and replacing them with correct entries. When a transaction is
deleted in a computerized system, the postings to the accounts are automatically deleted. This
also removes the effect of the incorrect entry from the accounts. Alternatively, correcting entries
may also be used as described in Chapter 2.

The popular accounting software for small, medium and large sized businesses used in a
computerized accounting system are:
®
 QuickBooks and
 Peachtree Accounting.

End Chapter Review Questions: Check your understanding!

1. Why would a company maintain separate accounts receivable ledgers for each customer, as
opposed to maintaining a single accounts receivable ledger for all customers?
2. What are the major advantages of the use of special journals?
3. Assuming the use of a two-column general journal, a purchases journal, and a cash payments
journal and indicate the journal in which each of the following transactions should be
recorded:
a. Purchase of office supplies on account.
b. Purchase of supplies for cash.
c. Purchase of store equipment on account.
d. Payment of cash on account to creditor.
e. Payment of cash for office supplies.
4. What is an electronic form, and how is it used in a computerized accounting system?
5. Do computerized systems use controlling accounts to verify the accuracy of the subsidiary
accounts?
6. What happens to the special journal in a computerized accounting system that uses electronic
forms?

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