Accounting: The Language of Business (Part 23)

“Any difficult task seems easier if you break it down into manageable steps.” —Unknown

Accounting Systems and Internal Controls

(Part D)

by

Charles Lamson

Manual Accounting Systems

After the internal control procedures have been developed, the basic processing method must be selected. Accounting systems may be either manual or computerized. Since an understanding of manual accounting systems assists managers in recognizing the relationships that exist between accounting data and accounting reports, we illustrate manual systems first.

In preceding posts, all transactions for NetSolutions were manually recorded in an all-purpose (two-column) journal. The journal entries were then posted individually to the accounts in the ledger. Such manual accounting systems are simple to use and easy to understand. Manually kept records may serve a business reasonably well when the amount of data collected, stored, and used is relatively small. For a large business with a large database, however, such manual processing is too costly and time-consuming. For example, a larger company such as AT&T has millions of long-distance telephone fees earned on account with millions of customers daily. Each telephone fee on account requires an entry debiting Accounts Receivable and crediting Fees Earned. In addition, a record of each customer's receivable must be kept. Clearly, a simple manual system would not serve the business needs of AT&T.

When a business has a large number of similar transactions, using an all-purpose journal is inefficient and impractical. In such cases, subsidiary ledgers and special journals are useful. In addition, the manual system can be supplemented or replaced by a computerized system. Although we will illustrate the manual use of subsidiary ledgers and special journals, the basic principles described in the following paragraphs also apply to a computerized accounting system.

Subsidiary Ledger 

An accounting system should be designed to provide information on the amount due from various customers (accounts receivable) and amount owed to various creditors (accounts payable). A separate account for each customer and creditors could be added to the ledger. However, as the number of customers and creditors increases, The ledger becomes awkward to use when it includes many customers and creditors.

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 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, you may think of a subsidiary ledger as a secondary ledger that supports a controlling account in the general ledger.

The individual accounts with customers are arranged in alphabetical order in a subsidiary ledger called the accounts receivable subsidiary ledger, or customers ledger. The controlling account in the general ledger that summarizes the debts and credits to the individual customer accounts is Accounts Receivable. The individual accounts with creditors are arranged in alphabetical order in a subsidiary ledger called the accounts payable subsidiary ledger, or creditors ledger. The related controlling account in the general ledger is Accounts Payable. The relationship between the general ledger and these subsidiary ledgers is Illustrated and Exhibit 4.

EXHIBIT 4

Special Journals

One method of processing data more efficiently in a manual accounting system is to expand the all-purpose two-column journal to a multi-column journal. Each column in a multi-column 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, and another special column could be used only for recording a credit 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 often repeated.

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 upon 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. On the other hand, a business that does not give credit would have no need for such a journal. In other cases, record-keeping costs may be reduced by using supporting documents as special journals.

The transactions that occur most often in a small- to medium-size service business and the special journals in which they are recorded are as follows:

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 2005, 21ST ED., PP. 190-192*

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