Accounting System: Definition, Types and Example

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Pratibha Devasenapathy | Jan-13-2020

What is an Accounting System?

Learning and keeping a track of your revenue is of key importance to any business. While there might be different accounting systems, depending on a company’s structure it goes without saying that maintaining updated books of accounts is the most important activity in a business. The commonalities between all companies accounting systems are; to manage the financial activities of a business, such as its revenue, expenses and liabilities. In this digital age, most accountants use sophisticated systems featuring overdue payment reminders, advanced reporting capabilities, automated data backups, and more.

Before accounting systems became automated, manual bookkeeping was being practised, which wasn’t just a cumbersome task but also prone to inaccuracies and time consuming. Computerised accounting has managed to take extra load off of entrepreneurs and accountants, making accounting simple and reliable. Accounting systems help calculate the wages paid and payable to employees, record transactions, check credit turnover ratios and process data related to sales, payroll, inventory and other key aspects of your business.

Types of Accounting Software

Choosing an accounting system depends on your budget, preferences and business size. The four main types of financial software systems include:

  • Single-entry systems
  • Double-entry systems
  • Manual accounting systems
  • Computerized accounting systems

These can be further broken down into several other categories, such as; custom accounting software, enterprise resource planning software, commercial off-the-shelf software and more. Modern-day software solutions like Tally offer varied capabilities which make your everyday accounting tasks a cakewalk.

Single-entry systems are the most basic option. As their name suggests, they record each transaction with a single entry in the accounting journal. This method is easy to use and doesn't require any technical expertise in accounting. It appeals to small companies with a low volume of transactions. However, the downside is that it's prone to errors and doesn't track accounts receivable, accounts payable, liabilities and more. Thus, most types of financial software systems now, including those designed for small enterprises, use double-entry bookkeeping. This means that every transaction will involve at least two accounts, which allows for more accurate reporting and timely error detection.

Example

Let’s look at a simple example to explain the double entry system to help you understand this accounting system better! Eg: A merchandise manufacturer purchases delivery trucks on credit. The total credit purchase is of INR 50,00,000. All new trucks will be used in daily business operations and will not be sold for the next 10 years. The estimated life of trucks is 10 years. Here’s how the double entry system to record this transaction will work.

Since, this is a credit purchase of trucks, for this transaction, there will be two activities, one is credit purchase of the trucks and another is an addition in new inventory. Entries are first recorded in their respective accounting ledgers. As the business has accumulated the assets, a debit entry will be made in inventory with INR 50,00,000. Since this is a credit purchase, an entry with an equal amount has to be made on the credit side in accounts payable. We see that the debit entry increases the inventory asset balance and credit entry increases the accounts payable liability balance with the same amount.

Double entries can also affect the same class of accounts. If the merchandise manufacturer would have bought the trucks in cash, then a credit entry has to be made in cash account and a debit entry to the inventory account. No matter what, the result in balance will be the same.

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