Nature of business organisation and accounting systems

1 Introduction

This chapter gives a brief introduction to organisations, double entry bookkeeping, and manual and computer-based accounting systems.

2 The organisation, and the main functions of an office as a centre for information and administration.

An organisation can be defined as:

A social arrangement which pursues collective goals, which controls its own performance and which has a boundary separating it from its environment.

Organisations can include businesses such as companies and partnerships, clubs, charities, government departments, hospitals and schools.

Most organisations have some sort of internal structure. For example, a manufacturing business will have a factory where goods are made, a warehouse where they are stored and offices where information is stored and administration carried out. Each of these can then often be subdivided. For example, a factory might be subdivided into component production, assembly and finishing departments.

An office typically has departments for the following:

• Finance and accounting
  

• Purchasing goods and materials
  

• Sales and marketing
  

• Wages and salaries
  

• Information technology
  

• Human resources management
  

These departments allow administration tasks to be carried out (such as ensuring orders are placed for materials, that customers are billed for their purchases and that employees are paid their wages and salaries).

They also hold the information that is essential for running a business such as: which customers owe us money, how many items we have in inventory, who our best customers are, what our most profitable sales are and so on.

Typically the departments are shown on organisation charts.

2.1 Functional organisation

In the diagram above the departments are arranged by function.

2.2 Divisional organisation

Divisions are often determined by geographical area (for example, a European Division and an Asian Division) or by product (for example, a Car Division and a Truck Division).

The divisional arrangement can allow each division to specialise.

As you go down an organisation chart, there is usually less power and authority at each level. Therefore, there is a hierarchy of superiors and subordinates and this allows organisations to be coordinated so that their collective goals can be achieved. It also allows responsibility and decision-making to be spread down the organisation. This is known as decentralisation and it leaves senior managers time to concentrate on the most important decisions whilst more junior staff will have responsibility for less important matters. Decentralising or delegating responsibility to junior staff members can be very motivating for them and also allows specialist decisions to be made by appropriate experts. However, there is always a danger that decentralisation results in poor coordination between departments and decisions have to be monitored carefully.

3 The function and use of a manual of policies, procedures and best practices.

It is normal for organisations to develop and document a set of policies, procedures and best practice. These perform the following important functions:

• Guidance for employees eg on holiday entitlements
  

• Training and instruction eg on how to request replacement of a piece of equipment
  

• Uniformity of approach eg that all employees are subject to the same discipline
  

• Meeting legal requirements eg health and safety rules
  

• Maintenance of operating standards eg on how to follow up customer complaints
  

• Maintenance of efficiency eg how to process an application
  

• Maintenance of security eg how to use computer passwords and back-up procedures.
  

4 The main types of transactions undertaken by a business and the key personnel involved in initiating, processing and completing transactions.

The main transactions undertaken by a business and the key personnel are as follows:

Purchase of raw materials:   this will usually be initiated by someone in the warehouse or factory who can see that more materials will soon be needed. Often this person raises a purchase requisition which goes to the buyers’ department. Buyers will then order from the most suitable supplier. Goods will be received in the warehouse and these must be checked back to the order to ensure that the correct goods are being received. Invoices from suppliers will be received and processed by the accounting department.

Sales:   in a retail organisation sales will be initiated by customers either in a shop or through the internet. Payment will usually take place immediately. In businesses selling to other businesses, the sales representatives (sales men and sales women) will be responsible for encouraging customers to place orders. Once received, orders should result in goods being despatched from the warehouse and invoices being created and sent to the customers by the accounting department. The accounting department will also record what each customer owes. Once payment is made, this will be recorded by the accounting department. If payment seems slow then the credit control department might contact the customer in the hope of speeding up payment.

Paying employees:   large organisations will have a wages and salaries department which is responsible for calculating amounts owing, and dealing with employees who leave and with new joiners. The amounts to be paid will usually be passed to the accounting department which will look after the cash transfers to employees.

Paying other expenses:   often, these will be recurring items such as rent, electricity, telephone and insurance. Sometimes they will be once-off like paying for an advertisement in a newspaper or for the repair of a piece of equipment. The invoices will be processed by the accounting department who will make sure that the expenses look reasonable compared to previous amounts or who will ensure that the services have been properly ordered and received.

Purchase of non-current assets:   The purchase of these assets will often begin with an employee raising a purchase requisition, for example for a new printer, which is then authorised by a manager or by the company accountant. When the invoice is received, someone needs to ensure that the asset has been received and that it is working properly.

5 The need for effective control over transactions

In large organisations, which typically can have thousands of transactions, it is very easy for

• errors to be made
  

• unauthorised transactions to take place
  

• fraud to be carried out
  

Good control of all transactions is therefore necessary. ‘Internal control’ is the name given to the system used to control transactions. All transactions should be:

• authorised
  

• completely recorded
  

• accurately recorded
  

An important part of internal control is known as the segregation of duties. This means that transactions are broken down into different stages with a different person being responsible for each stage. So in a purchase transaction, one person should order the goods, another receive and check them, and a third person should pay for them. Because several people are involved in the transaction it will be more difficult for unauthorised transactions to slip through; also each person, to some extent, checks up on what the previous one has done. For a fraudulent transaction to be processed would probably require collusion (co-operation) between all the parties, and this can be dangerous for the fraudster to organise.

Other types of controls include: signatures to authorise amounts, control totals to ensure all transactions have been processed and the use of sequential documents to check if any go astray.

6 The principles and practice of double-entry bookkeeping

The basic principle of double entry bookkeeping is that there are always two entries for every transaction. One entry is known as a credit entry and the other a debit entry.

The entries are often displayed in ‘T’ accounts:

Here are some simple, common transactions:

Purchase of office stationery for cash:

Debit     Office stationery     (increase in an expense)

Credit   Cash         (decrease in an asset)

A cash sale:

Debit     Cash         (increase in an asset)

Credit   Sales         (increase in income)

A credit sale:

Debit     Receivables     (increase in an asset)

Credit   Sales         (increase in income)

Payment by a customer of an amount owing:

Debit     Cash         (increase in an asset)

Credit   Receivables     (decrease in an asset)

Purchase, on credit, of goods for resale:

Debit   Purchases   (increase in an expense. ‘Purchases’ is the name given to purchases for resale)

Credit   Payables   (increase in a liability)

You should understand that if the double entry has been carried out properly, then the sum of the debit entries should always equal the sum of the credit entries. This should be regularly checked by compiling a trial balance, which is simply all the accounts listed in debit and credit columns and the lists added up. The totals should always agree.

7 The use of ledgers and prime entry records in both integrated and interlocking accounting systems

The word ‘ledger’ means a book. In accounting systems there are usually three ledgers:

• The general or nominal ledger, which records all the ‘T’ accounts, such as wages, sales, purchases, electricity, travel, advertising, rent, insurance, repairs, receivables, payables and non-current assets. The cash and bank accounts are technically part of this ledger but are usually physically kept in a separate book because cash and bank transactions are so numerous.
  

• The payables ledger (also known as the creditors’ ledger and sometimes the purchase ledger). Although the total amount owed to suppliers is recorded in the general ledger, details of exactly what is owed to whom are also recorded here. There is a separate account for each supplier. The sum of the amounts owing in this ledger should agree with the payables balance in the general ledger.
  

• The receivables ledger (also known as the debtors’ ledger and sometimes the sales ledger). Although the total amount owed by customers is recorded in the general ledger, details of exactly what is owed from whom are also recorded here. There is a separate account for each credit customer. The sum of the amounts owing in this ledger should agree with the receivables balance in the general ledger.
  

A prime entry record (or book of prime entry) is where a transaction is first recorded.

These records consist of:

• The cash book: this records amounts paid into and out of the bank account
  

• The petty cash book: this records small amounts of cash paid for day to day expenses, such as buying postage stamps and teas or coffee for the office.
  

• The sales day book: sales invoices issued to credit customers
  

• The purchases day book: purchase invoices received from suppliers
  

• The journal: where adjustments, such as correcting errors, are first recorded.
  

Some businesses also have sales returns and purchases returns day books.

The books of prime entry serve to ‘capture’ transactions as soon as possible so that they are not subsequently lost or forgotten about.

The cash book and the petty cash book are part of the double entry system and record cash coming in and going out.

The day books and journal are not part of the double entry system, and entries are made from there to the ledgers.

In manufacturing businesses two types of information are needed:

Financial accounting information. For example, the amounts paid for purchases and wages. These are the amounts that appear in the financial statements published by businesses every year.

Cost accounting information. For example, how much materials and wages go into each item produced. This information is used internally by the company.

The same transactions may therefore have to be dealt with in two different ways: once for the accounting information and then again for the cost accounting information. There are two approaches to these requirements:

An integrated accounting system. Here, information is recorded once for the two separate purposes. This can save time and effort at the recording stage but might increase effort at the presentation stage.

An interlocking accounting system: Here, separate ledger systems are maintained for the financial information and the costing information. This increases the recording effort but can be more efficient later when presenting information.

8 The functions and benefits of a computerised accounting system

Most accounting information is numerical and, of course, computers excel at dealing with that type of data. Computerised accounting systems should offer the following advantages over manual systems:

• faster provision of information
  

• provision of information that would not be easily available without a computerised accounting system
  

• once the system is set up, cheaper information
  

• more accurate information because arithmetic and certain other errors will be eliminated.
  

Of course sometimes things go wrong and systems break down or incorrect information is produced. In particular, if incorrect data is entered, incorrect information will be produced (garbage-in, garbage-out, GIGO).

A computerised accounting system can be represented as:

For example:

Input:     Orders are input over the internet

Processing:   Prices are accessed on a product file and the order value worked out.
The customers’ account in the receivables ledger (now held on a computer file) is debited.
Inventory records (now on a computer file) are updated.

Output:   An invoice is printed for the customer.
Despatch information is displayed on a screen in the warehouse to show the goods that have to be sent.

There are several important pieces of terminology that you should know:

File:   A group of similar records.
So, a receivables ledger file contains records for each customer.

Record:   Each record refers to a single entity.
So, a customer record will hold all the information about a customer; a product record will hold all the information about a product. Records are collected together into files.

Field:   (Also known as an attribute.) Each field holds a separate piece of data relating to a record. Thus a customer record would have fields for: name, address, telephone number, credit limit, invoices outstanding, etc.

Key field:   The field that uniquely identifies a record.
For example, a part code or an employee number.

Character:   Characters make up fields and are typically a – z, 0 – 9.
Often a character holds no meaning on its own, but occasionally a character will be the whole field. For example M or F for male or female.

The type of data held can be divided into:

Transaction data:   this records information about each transaction and this data changes often as transactions progress and are completed.

Standing or reference data:   data that is relatively permanent such as names and addresses, descriptions and prices of products.

In general, there are two types of processing that can be carried out: batch processing and real-time on-line processing.

Batch processing:   transactions are accumulated into batches and then all processed together. Because transactions have to be accumulated it means that there is a delay in processing them so the information held in the accounting system is generally out-of-date. For example, if sales transactions were accumulated during the week and processed to the receivables file on the last day of the week, for most of the time the balances shown owing from each customer would be understated. The balances would be correct only just after processing. Batch processing is not so common now.

Real-time, on-line processing:   ‘real-time’ means that files are updated as transactions happen; ‘on-line’ means that the files are permanently accessible to be updated. For example, when you withdraw cash from a cash machine, the machine can access your bank account record (it is on-line) to see if you have the funds. When you take the money out your bank account is immediately updated (real-time).