Welcome to the Heart of Accounting!
Hello there! Welcome to your study notes for The Accounting System. If you’ve ever wondered how a massive company like Apple or a small local bakery keeps track of every single penny, you’re in the right place. This chapter is the foundation of everything else you will learn in AS Level Accounting. Don't worry if it seems like a lot of rules at first—once you see the "logic" behind it, it’s like solving a giant, satisfying puzzle!
1. The Accounting Equation: The Golden Rule
Before we record anything, we need to understand the balance of a business. Every business owns things (Assets), owes money to others (Liabilities), and owes the owner for their investment (Capital).
The relationship between these three is shown by the Accounting Equation:
\( Assets = Liabilities + Capital \)
An Everyday Analogy:
Imagine you buy a laptop for \$1,000. You used \$600 of your own savings and borrowed \$400 from a friend.
Your Asset (laptop) is \$1,000.
Your Liability (friend's loan) is \$400.
Your Capital (your own money) is \$600.
\( \$1,000 (Asset) = \$400 (Liability) + \$600 (Capital) \). It balances!
Key Takeaway:
The equation must always balance after every single transaction. If it doesn't, an error has been made!
2. Double Entry System: Every Action has a Reaction
In accounting, we use Double Entry. This means every transaction affects at least two accounts. One account is Debited (Dr) and another is Credited (Cr).
How do you remember which is which?
Use the DEAD CLIC mnemonic. It’s a lifesaver for students!
DEAD (Debit these when they INCREASE):
Debit: Expenses, Assets, Drawings.
CLIC (Credit these when they INCREASE):
Credit: Liabilities, Income, Capital.
Quick Tip: If an item decreases, you simply do the opposite! For example, if you pay cash (an Asset) to buy a van, your cash decreases, so you Credit the Cash account.
Quick Review:
1. Identify the two accounts involved.
2. Decide if they are increasing or decreasing.
3. Apply DEAD CLIC to decide which is Dr and which is Cr.
3. Books of Prime Entry: The "Waiting Room"
In a busy business, you can't run to the main ledgers every time someone buys a candy bar. Instead, we write transactions down in Books of Prime Entry (also called Journals) first.
1. Sales Journal: For selling goods on credit.
2. Sales Returns Journal: For when credit customers send goods back.
3. Purchases Journal: For buying goods on credit from suppliers.
4. Purchases Returns Journal: For when we send goods back to credit suppliers.
5. Cash Book: For all cash and bank transactions (both in and out).
6. General Journal: For "unusual" things that don't fit elsewhere, like buying a van on credit or correcting errors.
Common Mistake to Avoid:
Only credit sales/purchases of goods for resale go in the Sales/Purchases journals. If you buy a machine for the office on credit, that goes in the General Journal, not the Purchases Journal!
4. Ledger Accounts and the Trial Balance
Once transactions are in the journals, we move them to Ledger Accounts (often called T-accounts because of their shape). At the end of a period, we calculate the balance of each account.
The Trial Balance
A Trial Balance is a list of all the balances from your ledger accounts. We put all Debit balances in one column and all Credit balances in another.
The Purpose: To check the arithmetical accuracy of the double entry. If the totals of the Dr and Cr columns are the same, your double entry was likely done correctly.
Did you know? Even if your Trial Balance totals match, your accounts could still be wrong! For example, if you recorded a \$50 sale in the wrong person's account, the math still works, but the record is incorrect.
5. Accounting Concepts: The "Ground Rules"
Accountants follow specific rules called concepts to make sure financial info is fair and useful. Here are the big ones you need for 9706:
Business Entity: Treat the owner and the business as totally separate people. If the owner buys a personal pizza with business cash, it’s recorded as Drawings, not a business expense!
Duality: Every transaction has two sides (Double Entry).
Historic Cost: Record assets at the price you originally paid for them, not what they are worth today.
Going Concern: Assume the business will keep running for the foreseeable future.
Prudence: Be "cautious." Don't overstate profits or assets, and record all possible losses immediately.
Matching (Accruals): Revenue and expenses must be matched to the same time period. If you used electricity in December, it counts as a December expense even if you don't pay the bill until January.
Materiality: Only record things that are "big enough" to matter. You don't need to track the value of a single paperclip over 5 years; just call it an expense now!
Substance over Form: Record the reality of a transaction, not just the legal paperwork. For example, if you "lease" a machine for its whole life, it’s basically yours, so record it as an asset.
6. Computerised Accounting Systems
Most modern businesses use software (like Xero, QuickBooks, or Sage) instead of paper books. While the logic of double entry stays the same, the process changes.
Advantages:
- Speed: Calculations are instant.
- Accuracy: No more human math errors.
- Reporting: Can generate a Profit and Loss statement at the click of a button.
Disadvantages:
- Cost: Software and training can be expensive.
- Security: Risk of hacking or data loss.
- System Failure: If the power goes out or the computer crashes, work stops.
Ensuring Data Security:
How do we keep the numbers safe?
1. Passwords: Only authorized staff can log in.
2. Backups: Save copies of the data off-site or in the cloud.
3. Firewalls/Anti-virus: To stop hackers and malware.
Key Takeaway:
Computerised systems are fast and efficient, but they are only as good as the person entering the data! Garbage in = Garbage out.
Don't worry if this seems tricky at first! You are learning a new language. Keep practicing your T-accounts and DEAD CLIC, and soon it will feel like second nature. You've got this!