UNIT 5: ACCOUNTING SYSTEMS

Contents
5.0 Aims & Objectives
5.1 Introduction
5.2 Components of Accounting Systems
5.2.1 Source Documents
5.2.2 Input Devices
5.2.3 Information Processors
5.2.4 Information Storage
5.2.5 Output Device
5.3 Fundamental Principles of Accounting Systems
5.3.1 Control Principle
5.3.2 Relevance Principle
5.3.3 Compatibility Principle
5.3.4 Flexibility Principle
5.3.5 Cost-Benefit-Principle
5.4 Special Journal and Subsidiary Ledgers
5.4.1 Subsidiary Ledgers
5.4.2 Special Journals
5.4.2.1 Advantages of Using Special Journals
5.4.2.2 Sales Journal
5.5 Computer Technology and Accounting Systems
5.6 Summary
5.7 Answer to Check your Progress Questions
5.8 Model Examination Questions
5.9 Glossary of Terms

5.0 AIMS & OBJECTIVES

After completing this unit, you should be able to:

- understand principles of accounting information systems
- list out the components of accounting information systems

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 - explain the purpose and use of special journals and subsidiary ledgers
- explain the impacts technology on accounting information systems.

5.1 INTRODUCTION

This unit introduces you to the components and principles of accounting systems.
A system is a way of doing something. There are various ways of doing things.

Let’s say you decided to go home when you go out of your office. There are many ways to do
that: You can either take a taxi or you can walk the whole distance home; you can take the
main road, or you may wish to use a short cut and so forth.

In accounting also, it is true that almost all business record, process and report business
transactions. However, the speed and efficiency of the processing depends on which
accounting system they use.

5.2 COMPONENTS OF AN ACCOUNTING SYSTEM

There are five basic elements of an accounting system. These are:

5.2.1 Source Documents
Source documents provide the basic information to be processed by the accounting system.
Invoices from suppliers, bills sent to customers, and payroll records are some examples of
source documents. You have already seen their meaning and importance in previous chapter.

5.2.2 Input Devices

Input devices capture information from source documents and enable its transfer to the
information-processing component of the system. Journal entries, both paper based and
electronic are a type of input devices.

5.2.3 Information Processors

An information processor is a system that interprets, transforms and summarizes information
for use in analysis and reporting. The information processing in an accounting system can be
manual or computerized.

Now a days, computer are being increasingly used to process information.

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Many businesses in Ethiopia, for example, use the Peachtree accounting software to process
accounting information.

5.2.4 Information Storage

After being input, processed data are usually saved for use in future analysis or report.
Information storage is the component of an accounting system that keeps data in a form
accessible to information processors.

5.2.5 Output Device

Output devices are the means to take information out of an accounting system and make it
available to users. Output devices include printers, and monitors, which provide such outputs
as financial statements, bills to customers and internal reports.

Check Your Progress Exercise -1

Give one example of an information storage device.
…………………………………………………………………………………………………
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5.3 FUNDAMENTAL PRINCIPLES OF ACCOUNTIG SYSTEMS

5.3.1 Control Principle

Any accounting information system should allow managers to control and monitor business
activities. To achieve this, accounting system must have internal control as an element.
Internal controls are methods and procedures that direct operations to one goal, ensure
reliability of financial reports and safeguard business assets. Internal controls are discussed
separately and at a greater detail in the next chapter.

5.3.2 Relevance Principle

The information that an accounting system provides should be relevant to decision makers.
This means, an information system should be designed to capture data that make difference in
decision. To ensure this, it is important that all decision makers, be considered when
identifying relevant information for disclosure.
5.3.3 Compatibility Principle

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The compatibility principle requires that an accounting system conform to the company’s
activities, personnel and structure. The system must also be customized to the unique
characteristics of the company.

All in all, accounting systems must be consistent with the aims of the company, i.e., they
should work in harmony with company goals.

5.3.4 Flexibility Principle

Accounting information systems must be flexible to adjust to changes in the company, in the
business environment and needs of decision makers. These changes can be technological
developments, consumer tastes or company activities.
A system must be designed to adapt to these and other changes.

5.3.5 Cost-Benefit-Principle
You wouldn’t do anything in your daily life with out first weighing the costs and the benefits.
Likewise, the benefits of performing an activity in an accounting system should be greater
than its costs.

For example, when you decided whether or not to report certain information, you have to
compare the benefits (its usefulness to decision making) and the costs (of computing,
personnel and other indirect costs).

5.4 SPECIAL JOURNALS AND SUBSIDIARY LEDGERS

5.4.1 Subsidiary Ledgers

When a business has so many customers and suppliers, a control account for Accounts
Receivable and a control account for Accounts Payable are established in the general ledger.
But in addition to these, subsidiary ledger for receivables and payables may be added to the
accounting system to show the balances for each individual customer and supplier separately.

A control account is an account in the general ledger that shows the total balances of all the
subsidiary accounts related to it.

Subsidiary ledger accounts show the details supporting the related general ledger control
account balance. For example, the subsidiary (supporting) accounts for accounts Receivable

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may be used to send out to each customer statements showing the balance they owe the
company.

A subsidiary ledger is therefore, a group of related accounts showing the details of the
balance of general ledger accounts.

Subsidiary ledgers are used to relieve the general ledger of a mass of detail. Thereby, the
general ledger trial balance is shortened. What’s more, having separate ledgers promotes the
division of labor as one employee can handle the control account while its subsidiary can be
assigned to another employee.

The relationship between a control account in the general ledger and its subsidiary accounts
can be illustrated as follows in T- account form.

Control account in the Subsidiary accounts in the

General Ledger Accounts Receivable subsidiary
Ledger
Accounts Receivable Customer A Customer B
2001 2001 2001
Dec. 31 Dec. 31 Dec. 31
Bal. 10,000 Bal. 1,000 Bal. 4,000

Customer C Customer D

2001 2001
Dec. 31 Dec. 31
Bal. 2,000 Bal 3,000

As you can see the sum of all balances in the subsidiary accounts (1,000 + 2,000 + 4,000 +
3,000) on December 31, 2001 is equal to the balance in the control account (10,000).

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When a transaction is recorded as a journal entry, it must indicate which of the subsidiary
ledger accounts is affected. Posting will be made to both the control account and the
subsidiary ledger account.

Example
A Br. 450 sale was made on account to Gome Balcha on January 2, 20X2. The journal entry
would be:
Jan. 2 Accounts Receivable-Gome 450
Sales 450

The Br. 450 would be posted as a debit to both the Account Receivable control account in the
general ledger and G.Balcha’s account in the subsidiary ledger. The credit would, of course,
be to the Sales account in the general ledger.

The following can be a summary of what’s discussed above:

General ledger
Control Account Subsidiary ledger
Accounts Receivable Accounts Receivable subsidiary
Ledger (account for each customer)
Accounts Payable Accounts Payable subsidiary
Ledger (account for each supplier)
Office Equipment, Equipment subsidiary ledger
Delivery Equipment, (Account for each item of
Office Furniture equipment).

Check Your Progress Exercise-2

1. What factors would affect a company’s decision to set up subsidiary ledger accounts
for the general ledger accounts?
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…………………………………………………………………………………………………
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5.4.2 Special Journals
A general journal is an all-purpose journal where we can record any transaction. However, as
the transactions of a company increase, it is better to use special journals along with the
general journal to record transactions of similar type in one, such as sales on account or cash
payments. Special journals record transactions of a similar nature.

Special journals are designed to systematize the original recording of major transactions,
which occur very repeatedly.

The number and format of special journals used by a company depends on the nature and size
of the company’s business transactions.

The following are some of the typical examples of special journals used by most
merchandising businesses.

1. Sales Journals 2. Cash Receipt journal

for recording credit sales. for recording cash receipts.

3. Purchase journal
4. Cash payment journal
for recording credit
for recording cash
purchases.
payments

5. General journal
for transactions not
recorded in any of the
special journal

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5.4.2.1 advantages of using special journals
A- Time is saved in journalizing. The amount of writing is reduced because it is not
necessary to repeat the account titles printed already at the top of the special columns
for every debit and credit.

B- Time is saved in posting- many amounts are posted as column totals rather than
individually.

C- Detail is eliminated from the general ledger column. Totals are posted to the ledger
means that detail is left in the special journals.
D- Division of labor is promoted. Several persons can work simultaneously on the
accounting records. This allows management to fix responsibility and quickly locate
errors.

E- Management analysis is aided. The special journal can be useful to management in

analyzing classes of transactions, such as sales, because similar transactions are in one
place.

5.4.2.2 Sales Journal

The sales journal is used to record sales of merchandise on credit; sales on cash are recorded
in a cash receipts journal. Sales of assets other than merchandise on credit are recorded in the
general journal.

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Each transaction recorded in the sales journal has a debit to Accounts Receivable and a credit
to Sales. Therefore, only one column is needed for these two accounts. The posting reference
(P/R) column is not used when transactions are recorded; instead this column is used when
posting.

Posting

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Sales journal entries are posted as shown with the arrow line in the illustration. Individual
transactions in the sales journal are posted regularly (daily) to subsidiary customer accounts in
the accounts receivable subsidiary ledger. These postings keep customer accounts up to date.
The sales journals amount column is totaled at the end of the period. The total is debited to
accounts Receivable and credited to sales.

The other special journals are illustrated below. Their operation is almost similar to the sales
journal.

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Albert Co.

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5. 5 COMPUTER TECHNOLOGY AND ACCOUNTING SYSTEMS

Computer technology can be divided into two broad categories: hardware and software.

Computer hardware-is
hardware-is the physical equipment in a computerized accounting information
system. The physical equipment includes processing units, hard drives, modems, monitors,
printers, etc.

Computer software-
software- is the program that directs the operation of computer hardware.
Peachtree and Sun system are some example of accounting software that help to process
information.

Computer technology reduces the time and effort devoted to record keeping tasks.
Accountants can now concentrate on analysis and managerial type decisions and work with
less effort directed at record keeping tasks.

One added advantage of a computerized accounting system (as opposed to a paper-based

manual system) is that various computers in an organization can be networked. Networking
means linking or connecting computers with each other to give different users and different
computers access to a common database and programs.

Check Your Progress Exercise -3

1. “ With the increase in the computerization of accounting systems of many
organizations in Ethiopia, the demand for accountants would fall (decrease). This is
because accountants are going to be replaced by computers.” Do you agree with this
statement? If not, Why?

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5.6 SUMMARY

Although accounting systems vary from business to business the broad principles discussed in
this unit apply to all systems.

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These principles are the control, relevance, compatibility, flexibility and cost -benefit
principle.

5.7 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS

Check Your Progress Exercise - 1

Ledgers, either manual or electronic, can be examples of information storage devices.

Check Your Progress Exercise - 2

The nature and size of its transactions determine to what accounts subsidiary ledgers should
be set up. In addition the cost- benefit factor should be considered.

Check Your Progress Exercise - 3

Computers are never going to replace accountants. Of course, they make the processing of
data efficient and help reduce errors. However, there needs to be accounting professionals
who design how the computers work and who analyze and interpret the output of the
computers (financial statements).

5.8 MODEL EXAMINATION QUESTIONS

1. Assuming the use of a two-column general journal, a purchase journal and a cash
payments journal, indicate the journal in which each of the following transactions should
be recorded:

a) Payment of cash on account to creditor

b) Purchase of office supply on account
c) Purchase of merchandise for cash
d) Return of portion of merchandise bought in ‘c’
e) Purchase of store equipment on account
f) Withdrawal of cash by owner

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5.9 GLOSSARY

General ledger -the principal ledger that contains all the balance sheet and income statement
accounts.

Controlling Account-
Account- a summarizing account in the general ledger, which represents a
summary of subsidiary accounts.

Subsidiary ledger - a group of accounts, which contain detail regarding a controlling,

account.
Purchaser journal - a special journal for recording purchase of merchandise or other items
on account.

Cash payment journal-

journal- a special journal for recording payments of cash for any purpose.

Sales journal - a special journal for recording sale of merchandise on account.

Cash Receipts journal-

journal- a special journal for recording receipt of cash from any source.

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