Chapter 4: Recording Financial Accounting Information

1.1 Flow of Accounting Information

The eventual goal of accounting is to present fairly and accurately all financial transactions
in the financial statements.

The process starts with recording all business transactions with information available in the
financial documents and classifying them into the relevant ledger accounts through
computerised systems or journals. At year-end, balances of each ledger account form the
trial balance, which is used as a basis to prepare the financial statements.

Information from business transactions travels through the accounting system, which
eventually forms the financial statements.

Exam advice

The FA/FFA exam will assume the use of computerised accounting systems, as follows:

 Sales and purchases modules will be integrated into the accounting system. This
means that any sales invoices produced within the sales module will
automatically be recognised in the individual customer’s account (in the
receivables ledger) and the trade receivables, and sales, general ledger accounts;
Exam advice

and purchase invoices entered into the purchases module will be automatically
posted to the individual supplier’s account (in the payables ledger) and the trade
payables, and other relevant general ledger accounts (see section 4.1.1).

 The term ‘sales module’ or ‘sales system’ may be used. Equally the term
‘purchase module’ or ‘purchase system’ may be used.

 It will be assumed that manual journal entries would be required to the general
ledger in respect of acquisitions and disposals of non-current assets.

 Recording of bank and cash transactions will also be by manual journal entries for
both cash purchases and sales, payments to suppliers and receipts from
customers.

 Payroll is a manual process, meaning that a journal entry will need to be manually
entered into the general ledger weekly or monthly in respect of wages and
salaries.

 Inventory systems may be manual or integrated. If they are integrated, then it is

assumed that inventory levels are automatically checked before sales or purchase
orders are made, and inventory movements inwards will be updated
automatically to the general ledger purchases accounts. However, manual journal
entries would be required in both manual and integrated inventory systems to
transfer purchases to cost of sales and to record opening and closing inventory in
the cost of sales.

 Filing and archiving will be held electronically.

 Business Transactions

Business transactions are the day-to-day activities of the business that have a monetary
value. For a business to operate, it needs to generate income by making sales and incur
expenses such as purchases and overheads.

 Financial or Source Documents

A financial document is produced for each business transaction to record information about
individual transactions.

Sales, purchases, cash payments and receipts are business transactions. Their corresponding
documents are the customer (sales) invoice, supplier (purchase) invoices, cheque stubs and
remittance advice, respectively.

Financial documents in a computerised system may be automatically generated as

transactions are processed; controls will be implemented that make the source document's
creation, distribution, and authorisation mandatory before any transaction is recorded.
 Exam advice

In the FA/FFA exam, the term ‘customer (sales) invoice’ or ‘sales invoice’ may be used.
Equally, the term ‘supplier (purchase) invoice’ or ‘purchase invoice’ may be used.

 General Ledger Accounts

The general ledger contains all the individual ledger accounts used by a business for the
purpose of producing the financial statements.

Information from the source documents is classified into their respective ledger accounts
using double entries via computerised systems and manual journal entries. The general
ledger contains accounts for the assets, liabilities, capital, income and expenses of the
business.

For example, where a customer has purchased goods on credit (i.e. will pay later)
information on a sales invoice is posted into the trade receivables account and sales account
in the general ledger using double entries.

 Trial Balance

At the end of an accounting period, each ledger account is closed off, and the account
balance flows to the trial balance. The trial balance is a list of each ledger account’s closing
balances. An accountant prepares the trial balance periodically, usually once during year-
end.

If the information entered into the ledgers conforms to the fundamental principle of double-
entry, the trial balance should have equal debit and credit balances. The trial balance is
investigated to ensure no errors have occurred in recording the transactions.

 Financial Statements

Each ledger account balance in the trial balance is totalled and summarised into financial
statement categories: assets, liabilities, capital, income or expenses.

The statement of financial position provides an overview of a business’s assets, liabilities,

and capital at the financial year-end.

The statement of profit or loss summarises a business’s income and expenses during the
financial year. The profit or loss is the net of the business’s income and expenses.

 Detailed customer and supplier balances

In integrated systems, detailed customer and supplier account balances can be produced by
the sales and purchases modules. These typically show all outstanding invoices and may
also show earlier invoices matched to payment transactions.

The total of all the customer balances (in the receivables ledger) should be the same as the
total in the trade receivables balance in the general ledger. Similarly, the totals of all the
supplier balances (in the payables ledger) should be the same as the payables account in
the general ledger. Sometimes the totals in the detailed reports may not equal the balances
in the general ledger, and if this is the case, it will be necessary to find the reasons for the
differences.

The individual customer and supplier accounts are not in the general ledger, and do not form
part of the double-entry system. However, if there is an assumption that the sales and
purchase modules are integrated with the general ledger, then all invoices and credit notes
should automatically be posted to the individual customer and supplier accounts, so the only
reason for any difference would relate to payments, as these are updated manually to both
the general ledger accounts, and the individual customer/supplier accounts. It is therefore
possible that payments could be omitted (e.g. posted in the general ledger but not to the
individual customer/supplier accounts, or vice versa).

2.1 Types of Business Transactions

Business transactions are the day-to-day activities of the business that have monetary value
and are recorded in the accounting records.

The main types of business transactions are:

 Sales

Sales are the exchange of goods or services for money. These may be for cash or credit.
Cash sales are made in exchange for immediate cash payment, while credit sales are made
with a promise of payment to the business in the future.

 Sale Returns

Sales returns are faulty or incorrect goods returned by a customer due to faulty or damaged
goods being supplied. The value of sales returns is netted off against sales.

 Purchases

Purchases are the exchange of money for goods or services. Cash purchases are made in
exchange for an immediate cash payment, while credit purchases are made with a promise
to pay the supplier in the future.

 Purchase Returns

Purchase returns are faulty or incorrect goods sent back to the supplier due to faulty or
damaged goods being supplied. The value of purchase returns is netted off against
purchases, or against the relevant expense or asset account that was debited when the
purchase was originally entered into the system.

 Payments

Payments are the settlement or transfer of money to a third party.

 Receipts

Receipts are due to the business receiving money from a third party.

All financial transactions must have a valid financial document with details of the
transaction. For example, a sales transaction is recorded using an invoice.

2.2 Types of Financial Documentation

Bookkeepers record business transactions based on supporting financial documentation.
Financial documents (or source documents) provide evidence of the existence of financial
transactions.

 Quotation is a document sent by the seller with details of the price for each item. The
quotation highlights the quantity, description and price of the purchase required.

 Purchase Order is a document completed by the customer and sent to the supplier,
highlighting the items they want to order.

The purchase order contains the supplier’s name and address, a unique reference number,
the quantity and the description of the purchase. The business may also include its terms
and conditions regarding payment and the person responsible for placing the order.

 Sales Order is an internal document generated to process a customer order after

receiving it. It essentially translates the format of the purchase order received to the
format used by the business (seller).

The sales order contains the customer’s name and address, the quantity and descriptions of
the required products. There may also be notes specific to the order, including terms
specified by the customer.

 Delivery Note or Goods Dispatched Note is a document that accompanies the

delivered goods. The customer signs the delivery note to confirm proof of delivery
when the goods are delivered. The supplier also checks that the correct goods are
being sent.

The goods dispatched note contains the business's name, address, quantity and description
of goods being delivered.

 Goods Received Note (GRN) is an internal document completed by the customer to

ensure everything ordered has been received. The GRN lists the quantity and
description of the goods received.

 Customer (sales) invoice is a document sent to customers with details of the items
sold to the customer on credit. Details include the date, quantity, price, and parties
involved.

A sales invoice contains the seller’s and buyer’s name and address, as well as the quantity,
price, total value and sales tax on the sale. The seller’s payment terms will also be stated.

 Supplier (purchase) invoice is a document received from suppliers with details of

the items purchased on credit. Details include the date, quantity, price, and parties
involved.

 A purchase invoice contains the seller’s and buyer’s name and address, as well as the
quantity, price, total value and sales tax on the sale. The seller’s payment terms will
also be stated.

 Credit Note is a document issued by the supplier to reduce the value of the
previously issued invoice due to faulty or damaged goods being supplied.
A credit note contains the supplier’s and customer's name and address, as well as the
quantity, price, total value and sales tax on the returned sale.

 Debit Note is a document issued by the customer to the supplier to request a credit
note.

The debit note contains the customer’s and supplier’s name and address, the details of the
goods returned (quantity, price, total value and sales tax) and the reason for the return.

 Statement of Account is a document sent by a supplier to a customer with details of

all transactions between the parties. The statement also highlights the balance owed
to the supplier at the end of the month.

A statement of account contains the seller's and customer's name and address, invoice
numbers, outstanding amounts, and payments received. Credit note numbers and values
would also be included.

The statement of account’s primary purpose is to support reconciliation of the supplier’s

account. Supplier statement reconciliations are discussed in Chapter 6.

 Remittance Advice is a document sent to the supplier to show that payment has
been made.

The remittance advice contains the method of payment, such as an enclosed cheque or a
direct bank transfer, and details of the invoices covered.

 Receipt is a document issued by the business to the customer to confirm that a

payment has been received that pays any outstanding invoices.

A receipt contains the business's and customer's name and address, the amount paid by the
customer and a list of the invoice numbers that have been paid.

Key Point

Source documentation can be created and issued electronically through automated

processes, with the necessary fields populated from the accounting system’s
databases.

3.1 Purpose of General Ledger Accounts

Most users of financial statements do not require the detail of every transaction that large
businesses will encounter daily. Therefore, the financial information for each transaction is
entered in the general ledger accounts before being summarised and presented in the
financial statements.

Financial information from the source document is posted to the relevant ledger accounts
either automatically or through manual journal entry using the fundamental principle of
double-entry (see ‘The Journal’ later in this chapter).

The general ledger contains individual accounts for the assets, liabilities, capital, income and
expenses of the business. For example, where a customer has purchased goods on credit
(i.e. will pay later) information on a customer (sales) invoice is posted into the trade
receivables ledger account and sales ledger account in the general ledger.

The general ledger contains all the individual ledger accounts used by a business.

3.1.1 T-Accounts

The individual ledger accounts within the general ledger are called T-accounts, as they form
the shape of a ‘T’, as shown below:

3.2 Main General Ledger Accounts

3.2.1 Statement Of Financial Position Accounts

Statement of financial position accounts are those used for recording assets, liabilities and
capital transactions. These accounts are included in the statement of financial position:

Examples of statement of financial position ledger accounts are:

 Trade receivables – This asset ledger account records sales made where the
settlement has not been received. A debit entry into the trade receivables ledger
account increases its balance.

Credit sales increase the trade receivables balance, while payment received from credit
customers reduces its balance.

 Cash/Bank – This asset ledger account records the cash movements of the business.
A debit entry into the cash/bank ledger account increases its balance.

Receipts from customers increase the cash/bank balance, while payments to suppliers or
expenses reduce its balance.
  Trade payables – This liability account records purchases of goods and services for
resale that have been incurred but not yet paid. A credit entry into the trade payables
ledger account increases its balance.

Credit purchases increase the trade payables balance, while payment to credit suppliers
reduces its balance.

Asset and liability a/c

A DEBIT entry represents A CREDIT entry represents

1 an INCREASE in a ASSET; or 1 an INCREASE in a LIABILITY; or

2 a DECREASE in a LIABILITY. 2 a DECREASE in an ASSET.

2.2.2 Income and Expenditure Accounts

Income and expenditure (expense) accounts record the transactions determining profit (or
loss) for a period.

Examples of income and expenditure ledger accounts are:

 Sales – This income ledger account records the cash or credit sales of the business. A
credit entry into the sales ledger account increases its balance.

Sales generated by the business increase the sales balance. A sales return transaction
reduces the sales ledger account balance if no separate sales return ledger account is
maintained.

 Expenses – The expense ledger accounts record the purchases and other expenses
of the business. A debit entry into an expense ledger account increases its balance.

Purchases incurred by the business increases the purchases ledger account. A purchase
return transaction reduces the purchases ledger account balance if no separate purchase
returns ledger account is maintained.

Income and expenditure a/c

A DEBIT entry represents A CREDIT entry represents

1 an INCREASE in EXPENSE; or 1 an INCREASE in a INCOME; or

2 a DECREASE in a INCOME. 2 a DECREASE in an EXPENSE.

3.3 Balancing Off Ledger Accounts

Balancing the accounts is the first step in ensuring that the double entries have been
recorded correctly.
  To balance an account means to put in a balancing figure (balance c/d)

 Accounts can be balanced at any time, generally at every month’s end.

Key Point

General ledger accounts will always be balanced before they are closed at the end of a
reporting period when the financial statements will be drawn up.

3.3.1 Steps to Close off Ledger Account

Balancing off ledger accounts is applied systematically to every account.

1. Sum the debit side and note the total. Sum the credit side and note the total.

2. Whichever is the larger will be the total on both sides.

3. Insert the balancing figure so that both sides are equal (balance c/d)

4. If the sum of the debits exceeds the sum of the credits, the balancing figure is a debit
balance. This is brought down (b/d) on the account’s debit side.

If the sum of the credits exceeds the sum of the debits, the balancing figure is a credit
balance. This is brought down (b/d) on the credit side of the account.

Example 1

The below T-Account is Manisha's Bank account in the general ledger for the year ended
31st December 20X6: her first year of trading.

Manisha has posted cash receipts and payment entries into the Bank ledger account as
shown and is now closing her accounts.

DR Bank (Asset) CR

31-Mar-X6 Cash Receipts $300 31-Mar-X6 Cash Payments $220

30-June-X6 Cash Receipts $800 30-June-X6 Cash Payments $160

30-Sept-
X6 Cash Receipts $400 30-Sept-X6 Cash Payments $720

31-Dec-X6 Cash Receipts $500 31-Dec-X6 Cash Payments $80

Balance c/d
31-Dec-X6 (S3) $820

(S2) (S2)
$2,000 $2,000

01-Jan-X7 Balance b/d $820

 Example 1

(S4)

To close the Bank ledger account, the following steps are made:

1. Sum the debit and credit sides:

Total Debits = $300 + $800 + $400 + $500 = $2,000

Total Credits = $220 + $160 + $720 + $80 = $1,180

2. Since the debit side is higher than the credit, the total to be included in the ledger
is $2,000.

3. Insert the balancing figure so that the sum balances.

4. Since the sum of the debit side is larger than the credit, the balance c/d will be
brought down as the opening amount on the debit side for the following period.

In this case, Manisha has a closing bank balance of DR $820 which will show on the
debit side of the Bank ledger in the following financial period.

3.3.2 Application of Ledger Close-off

Ledger accounts that contain balances used in the preparation of the statement of financial
position are treated differently from those ledger accounts used for the statement of profit or
loss.

 Statement of financial position ledger accounts

These are asset, liability and capital accounts. The closing balances for this year are the
opening balances for next year. The ledger accounts show balances carried down and
brought down, as seen for the bank ledger account in the earlier example.

 Statement of profit or loss ledger accounts

These are income and expense accounts. Profit is calculated as income minus expenses and
becomes part of capital at the year’s end.

The ledger accounts will reference the statement of profit or loss instead of the balance
carried down. There is no brought-down balance because the balances will all be transferred
to the profit or loss ledger account at the year’s end. The profit or loss ledger account is
created at year-end and is transferred to the capital section of the statement of financial
position.

4.1 Computerised Accounting Systems

Technological advancements make it unlikely that financial transactions are recorded on

paper. Instead, business transactions are now recorded using a computerised accounting
software system.

Using a computerised system, a bookkeeper may input details of the source document, and
an automated double-entry is generated to the relevant ledger accounts.
In a computerised system, activities are categorised into three processes:

 Inputs – Inputs are data entered into the accounting system from the source
documents.

 Processing – Data entered is posted into the relevant general ledger accounts

 Output – Financial statements and other reports are produced for management use

4.1.1 Features of a Computerised System

 A typical computerised accounting system comprises several modules to operate

different business functions such as sales, purchases, inventory, receivables and
payables.

 Computerised information can be integrated with other management modules to

update transaction trails. For example,

o Sales invoices generated through the sales module are automatically posted into
the receivables or cash ledger accounts. It can also update the inventory system
to record its movement and reduce the quantity.

o Purchase invoices are entered into the purchases module, and the relevant
ledger accounts, such as the payables, inventory, and any other relevant general
ledger accounts, are updated.

 Back-ups of the data in a computerised system are available in the event of lost files.

 Authorisation of transactions by senior personnel is done through PINs, passwords,

security tokens or apps. For cloud-based systems, authorisation may be done remotely.

 A computerised system allows you to amend transaction details and keep a log of
the changes.

 There is a reduced likelihood of errors and omissions as computer systems do not

allow error data to be processed.

 Real-time comprehensive and accurate management reports can be generated

cost-effectively.

Examples of output reports from a receivables ledger system include:

o Customer (sales) invoice

o Customer statement

o Trade receivables ageing list

o Sales analysis report

Examples of output reports from a payables ledger system include:

o List of outstanding supplier balance

o Purchases analysis report

4.1.2 Desktop vs Cloud Accounting Systems

A desktop accounting (on-premise) software system is hosted on a computer’s hard drive.
The software is initially installed on the business premise’s desktop and is maintained
regularly.

A cloud accounting software system is hosted, updated, and maintained online. The
organisation pays a fee to a service provider that hosts the software on remote servers.

Desktop Software Cloud Software

Accessible on the desktop where Accessible only with an internet

software is installed Accessibility connection

Single access. Only one person Multiple users can use the software,
can use the software at a time Users even remotely.

Updates and Backup need to be Updates and Automatically updates and backups
performed manually Backup data to an online server

One-time fee until renewal Pricing Monthly subscription fee

Needs installation Installation No installation required

Security tied to the desktop. Security depends on the cloud

Data can be lost if the computer software system, usually with
crashes or breaks down. Security multiple layers of encryption.

4.2 Sources of Information

The accounting system will draw information from several sources to facilitate processing:

Source Description Example

A human keys  A cashier inputs customer purchases

transactional information with a bar code scanner, then captures
into the system, usually payment information with a point-of-
through a terminal. sale payment device that reads the
customer’s credit card.
Hardware input devices
such as scanners or  A clerk keys in the details of an invoice
Manual barcode readers may into the accounting system at a
data entry support this. terminal for processing.

Computer- An automated system  The accounting system automatically

assisted reads an input source and reads emails and attached documents
data entry updates the necessary received from customers from its
 fields in the accounting
system data entry. purchasing email address and
automatically populates the fields for a
This process may be
sales order to be authorised.
assisted by robotic
process automation and AI  A robot automatically scans, detects,
that can identify and read and records RFID tags attached to
documents and other inventory to update inventory records
input. automatically.

 The system will automatically query

approved supplier data to populate the
necessary fields for a requested
purchase order.
Files that store large
 The system will collate and aggregate
amounts of data.
a customer’s transaction history to
It may contain customer process a request for the customer’s
and supplier master data statement for outstanding trade
Databases and transaction history. receivables.

 When a customer’s supply of material

Accounting systems may runs low, an automatic purchase order
be integrated with the is sent to the business’s accounting
systems of suppliers and system, verifying the order and
Integrated customers to facilitate the creating a sales order and despatch
systems fast processing of orders. note automatically.

4.3 The Journal

4.3.1 Automatic Transaction Processing

As explained in section 4.1.1, in integrated systems, most routine transactions are posted
automatically by the relevant modules. For example, when a customer (sales) invoice is
generated in the sales module to record a credit sale, a transaction will be automatically
posted in the general ledger, applying the fundamental principle of doubleentry, as follows:

General Ledger $
Account

Debit Trade receivables X

Credi Sales X
t
 Exam advice

In the FA/FFA exam, for transactions which are automatically posted to the general
ledger, such as the example above, you may be required to identify the double-entry
(i.e. which account is debited and which account is credited, as shown above).
Alternatively, you could be asked to prepare a journal entry (see ‘manual journal
entries’ below), even though the transaction would be processed automatically. This is
to test your understanding of double-entry principles.

4.3.2 Manual Journal Entries

Where transactions are not posted automatically to the general ledger, they will need to be
posted manually and recorded in the journal. The posting of manual transactions is referred
to as manual journal entries.

Definition

The journal is a record of accounting entries (or journal entries) posted to the general
ledger to enter non-routine transactions or correct errors. A journal entry refers to the
manual posting of an accounting transaction to the general ledger.

Journal entries have the following format (for example to record a payment of wages):

General Ledger $
Account

Debit Wages X

Credi Bank X
t

Journal entries also include a brief explanation e.g. ‘to pay wages’, and the relevant general
ledger account codes for the particular accounting system used by the business.

In the FA/FFA exam, as discussed at the start of this chapter, there will be an assumption that
the sales and purchases modules are integrated with the general ledger. So transactions
related to customer (sales) invoices and credit notes, and supplier (purchase) invoices and
credit notes will be posted automatically to the general ledger. It will be assumed that all
other transactions will be recorded manually, using journal entries. This includes cash and
bank transactions, transactions relating to non-current assets, inventories and accruals and
prepayments.

4.4 Accounting Systems

 Definition

Accounting system – The records and procedures, both formal and informal, which
relate to the assembling, recording, retrieval and reporting of information related to the
financial operations and which also provide necessary internal controls.

A sound accounting system:

 is necessary to ensure resources are allocated efficiently and effectively.

 incorporates policies and procedures, including necessary internal controls, to assist

management in achieving organisational objectives.

4.4.1 Useful Accounting Information

Accounting is concerned with the collection, analysis and communication of financial

information which users need for decision-making purposes.

For information to be useful, it must possess certain qualities. It must be:

 relevant to the needs of the user

 reliable (complete, accurate and objective)

 complete for the purpose(s) for which it is intended

 accurate so that users have confidence in it

 objective (without bias)

 comparable to make meaningful comparisons

 cost-effective (the cost of preparation does not exceed its value)

 user-friendly so that it is understandable and clear

 concise (distinguishing important matters and ignoring trivia)

 timely so that information arrives on time to inform decisions.

4.4.2 Organisational Objectives

Management must ensure, as far as possible:

 Orderly and efficient business conduct, including adherence to management policies

 That assets are safeguarded

 The prevention and detection of fraud and error

 The accuracy and completeness of the accounting records

 Timely preparation of reliable financial information.

Internal controls relating to the accounting system seek to ensure that:

 transactions are authorised and valid

  all transactions and other events are recorded promptly at the correct amount, in the
appropriate accounts and the proper period (accurate and complete)

 access to assets and records is restricted

 recorded assets (e.g. in an asset register or perpetual inventory records) are compared
with physical assets periodically (and appropriate action is taken regarding any
differences).

4.5 Policies, Procedures, and Performance

Accounting is concerned with providing useful economic information which will be helpful to
those directly (and to some extent indirectly) connected with an organisation.

Although only part of the broader business system, all elements of the business system rely
directly (to some degree) on accounting information.

The information provided by the accounting function should:

 Assist management in planning, controlling and decision-making;

 Assist business functions in achieving their objectives;

 Assess the performance of the various areas in an organisation;

 Assess the performance of the managers of the organisation; and

 Enable compliance with various statutory requirements (e.g. Annual financial

statements).

4.5.1 Policies

Policies are the principles, rules or guidelines for achieving an organisation’s long-term goals.
There are many policies covering areas such as pricing, pay, asset replacement, etc.

4.5.2 Procedures

Procedures are step-by-step activities for completing a task. For example, accounting has
procedures for recording sales and purchases.

4.5.3 Performance

Performance concerns outcomes and results – how well or badly actions have been carried
out and what the outcomes are.

For example, whether the company’s profits are higher or lower than expected.

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