Thursday, 8 April 2010

Accounting Business Transactions

We have been looking at accounts, what they are and the types of accounts that businesses maintain. Let us now look at how accounts are maintained.

A tiny business might just note down brief details of business transactions in a small notebook. It might periodically summarize the entries thus made to know current status, or to take specific action such as billing a customer.

As the number of transactions goes up, the above method can prove quite impractical. The business might even lose money that it could have recovered with better accounting. Probably worse, the business might find itself facing claims that it cannot contest for want of details in a timely manner.

It is at this stage that a proper system of accounting becomes critical. This can be a Single Entry system where essential details, such as those needed to recover moneys due or contest claims, are maintained. A Double Entry system provides full details of business transactions. Let us look at this statement in a little more detail.

Every business transaction involves an exchange of value, involving both a receipt of value and giving of value. For example, if you buy something for cash, the thing you bought is received by you and you give cash in exchange. If the transaction is a credit transaction, instead of cash, you give an obligation to pay later.

In a double entry system, both the receiving and giving aspects are recorded. The cash transaction above will be reflected in a Purchase account and Cash account, for example. The credit transaction will involve the seller recording an amount as due from the buyer, and buyer recording a similar amount as due to the seller.

The double entry system of accounting is thus more complete and portrays a more correct picture of business transactions.

In our next post, we will look at the typical procedures used for accounting business transactions.

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