Systems of Accounting¶
There are two main systems of accounting used to record business transactions. These are the Single Entry System and the Double Entry System.
1. Single Entry System¶
The Single Entry System is a simple method of bookkeeping where only personal accounts (with or without subsidiary books) are maintained. This system does not provide a complete record of business transactions for a specified period.
Key Characteristics:¶
- Incomplete Records: In a single entry system, only limited information is recorded, typically focusing on cash and personal accounts. Nominal accounts (related to expenses and income) and real accounts (related to assets) are generally not maintained.
- No Trial Balance or Final Accounts: Due to the lack of complete records, neither a trial balance nor final accounts (such as profit and loss statements or balance sheets) can be prepared.
- Simple and Inexpensive: The system is easy to use and inexpensive to maintain, making it suitable for small businesses or individuals with few transactions.
- Lack of a Structured System: Since it does not provide a comprehensive overview of the business’s financial position, the single entry system is often considered a lack of system rather than a formal accounting method.
Application:¶
The Single Entry System is primarily used by small businesses or individuals who do not require detailed financial records. However, it has significant limitations, especially when it comes to preparing accurate financial statements and assessing the complete financial health of a business.
2. Double Entry System¶
The Double Entry System is the most widely used and accepted method of accounting. It was developed by an Italian merchant named Luca Pacioli, who published the first book on this system, titled 'De Computis et Scripturis', in 1494.
Key Characteristics:¶
- Two Aspects of Every Transaction: Every business transaction affects two accounts—one account is debited, and another account is credited with an equal amount. This reflects the dual aspect of transactions, such as receiving something in exchange for giving something else.
- Example 1: When a business purchases goods for cash, it receives goods and gives cash. The inventory account is debited, and the cash account is credited.
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Example 2: In a credit sale, the business gives goods to the customer and receives a debtor in return, meaning the customer owes money to the business. The debtor's account is debited, and the sales account is credited.
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Balanced Accounting: Because every transaction has a corresponding debit and credit, the total of all debits must always equal the total of all credits. This ensures that the books remain balanced, allowing for the preparation of a trial balance to verify the accuracy of entries.
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Preparation of Financial Statements: The double entry system provides a complete record of transactions, allowing businesses to prepare accurate final accounts, such as the profit and loss statement and balance sheet. These statements provide a true and fair view of the company’s financial position.
Advantages:¶
- Comprehensive Records: Unlike the single entry system, the double entry system captures all aspects of business transactions, providing detailed financial records.
- Accurate Financial Statements: Since every transaction is recorded in two accounts, this system ensures that businesses can prepare accurate and reliable financial statements.
- Error Detection: The requirement for debits to equal credits allows for the detection of errors through the use of a trial balance.
Conclusion:¶
In summary, the Single Entry System is a basic method used primarily by small businesses that do not need comprehensive financial information. However, it is limited by its incomplete record-keeping. The Double Entry System, on the other hand, is a structured and reliable system that records every transaction in two accounts, ensuring that businesses can prepare accurate financial statements and maintain balanced accounts. This system is widely accepted and is essential for businesses that require a detailed and accurate record of their financial activities.
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