There is a cycle of action in accounting for any business. This cycle is depicted diagrammatically below:
What do all these new words mean?
1. SOURCE DOCUMENTS – Source documents are documents, such as cash slips, invoices, etc. that form the source of (and serve as proof for) a transaction. In other words, they are the first documents that exist relating to a transaction.
In my lesson on source documents you will see examples of invoices, cash slips, receipts, check counterfoils, bank deposit slips and even internet payment confirmations.
2. JOURNALS - These are chronological (date-order) records of transactions entered into by a business. Journals are that first basic entry of debit and credit for each transaction. In the examples we have been doing in the previous chapters, where we have debited one account and credited another, we have been doing journals.
There are actually a few types of journals, and they don't all look exactly like the above debit and credit. We'll run through each of them in the second lesson on accounting journals, from the cash receipts journal to the general journal, so you get a good idea of what each one is for and how it works.
3. LEDGER (T-ACCOUNTS) - The ledger is a collective term for the accounts of a business (a ledger of accounts is like a school of fish). The accounts are in the shape of a ‘T’ and thus are often referred to as ‘T-accounts’. In this step we take all the debits and credits (journals) relating to one account – let’s say ‘bank’ – and draw up an account for bank that shows all the transactions relating to it.
There a few lessons available on T accounts. In our first T-account lesson called T Accounts we'll look at how to draw up a T-account.
Next we'll look at posting journals (posting means transferring information from the journals to the T accounts).
And, in our final lesson on T accounts, we'll go over control accounts and take a closer look at the debtors and creditors ledgers.
4. TRIAL BALANCE - A sheet displaying all the accounts of a business, drawn up as a trial (test) of whether the total of all the debit balances equal the total of all the credit balances (A balance is the amount of an item at a point in time. For example, The balance in the bank account on the 1st of January was $5,000.). The trial balance is prepared as a final check just before the financial statements are drawn up. Click here for a brief lesson on the trial balance.
5. FINANCIAL STATEMENTS - A statement is a report. Financial statements are the most important reports of a business. These statements are prepared from the information in the trial balance. The purpose of these statements is to show the reader the financial position, financial performance and cash flows of a business, as well as other useful information concerning the business. Financial statements are usually prepared once a year.