FAQs

Q. What does the term 'double-entry' mean?
A. Every transaction in a double-entry accounting system has two sides: where the money came from and where it went to. For example, when you make a sale the money comes from your customer and goes to your bank. In a double-entry accounting system you would record two entries; one would credit your customers account and the other would debit your bank. This dual aspect of a transaction is what the term double-entry means.

Double-entry is present in every professional computer accounting application, but it is sometimes not obvious. For example, when 'writing out a cheque' on screen you will usually be presented with a graphical representation of a cheque. The system 'knows' that the cheque will affect the credit side of the transaction, so all you are doing is filling in the debit side (who you are paying the money to). These systems are fine..until something goes wrong and you have to make 'correcting' entries. This is why a basic knowledge of double-entry is important (even if the manual says 'dont worry about debiting and crediting, it's all taken care of!') - Top

Q. What do the terms 'debit' and 'credit' mean?
A. The terms debit and credit refer to the way money flows from one account to another. In every transaction one side will debit an account, and the other side will credit another (see Q1). - Top

Q. What is a 'journal'?
A. A Journal is a place where your transactions are first entered. In a manual system this would simply be a book consisting of columns which hold the date, amount and accounts affected by each transaction. In modern computer accounting programs they are rarely displayed this way, instead you may have a 'cheque' displayed on screen for you to fill in when making a payment, or an 'invoice' when making a sale. Behind the scenes though, the details of your transactions will still be held in a computerised version of the traditional accounting book or 'journal'. - Top

Q. What is a 'ledger'?
A. A Ledger is a book in which your original entries from the journal (see previous answer) have been sorted into separate accounts. A journal therefore holds all your transactions in date order and a ledger is a resorting of your transactions by account. - Top

Q. What does the term 'posting' mean?
A. Your transactions are first entered into a journal (see Q3). They are then copied into a ledger (see previous answer). The action of copying entries in a journal to a ledger is called Posting. - Top

Q. What is a 'trial balance'?
A. A Trial Balance is a list of each accounts balance. Those with credit balances are added together, and likewise, accounts with debit balances. If the total credits equal the total debits, the accounts balance and a balance sheet can be prepared (see next answer). - Top

Q. What is a 'balance sheet'?
A. A Balance Sheet is a summary (or statement) of all the accounts used in a business. If an account has a debit balance it is usually shown on one side of the balance sheet under a heading called 'assets' (these are things the business owns). If an account has a credit balance it is shown on the other side under a general heading called 'liabilities' (these are the things the business owes). If all the original transactions have been entered correctly into the journal, posted correctly to the ledger, and placed on the correct side of the balance sheet, the total of each side will equal each other (ie. the 'assets' will equal the 'liabilities'). This is why it is called a balance sheet. Balance sheets can be produced at any time, but are always produced at the end of each financial year of a business. - Top

Q. What are 'reversing' and 'correcting' entries?
A. If you discover a mistake in an earlier transaction, it is not usually a good idea to delete or amend it (especially if it was in an earlier accounting period which will affect your tax/VAT liability). Instead you should enter a completely new transaction to reverse the original, followed by another transaction (known as a 'correcting' transaction) to enter what really happened.

The new reversing and correcting transactions should be dated the day you found the error. The effect of this is that you will end up with three transactions: the original; the reversing one (which nullifies the effect of the original); and the correcting one. Because they will have different dates you will be accounting for everything and will have no problems with the tax authorities!

Q. Why do debits/credits seem to be the wrong way round?
Example: The original transaction debited a bank account and credited a cash account. Subsequently you discover that it was entered in error (ie. there was no such transaction). In this example you only need a reversing transaction to credit the bank and debit the cash.

Please note that 'reversing' and 'correcting' are only accounting terms; the transactions themselves are just like any other 'real' ones.

If you buy some petrol by cash you will credit the cash account and debit the petrol account. To understand why the cash account is credited when you are taking money from it the cash account (or whereever the money came from) should be thought of as a real cash box. When you remove some money to buy some goods, you should replace it with a receipt or petty cash slip to say what the money was used for. A receipt or petty cash slip is a form of credit note, so the cash box now contains a credit note instead of the cash, hence we show the entry as a credit. (Logically, if you returned the goods because they were faulty, the receipt would be given back in exchange for the cash).

Looking at the debit side, the petrol account now has the money, it got the money from cash so it is in debt to cash - hence it is entered as a debit. - Top

Q. What is the difference between a 'nominal' and other ledgers?
A. Most businesses keep their accounts using three ledgers: a purchase ledger for keeping track of supplier accounts, a sales ledger for customer accounts, and a nominal or general ledger for everything else. You could of course keep all your accounts in a single ledger and call it whatever you like, but splitting them up into different ledgers can make your accounts easier to view (it also allows more than one person to work on them at the same time). There are no rules on how many ledgers you care to split your accounts into, it all depends on the nature and size of your business. The names are of little importance either - they are simply descriptions which make your accounts easier to read, eg. in the USA the term 'general' ledger tends to be used, whereas in the UK it is often referred to as the 'nominal' ledger. The point being made here is this: whatever a ledger is called, its basic principle is the same; it holds the details of accounts.

Q. What is a 'flow of funds' statement?
A11: Firstly, a Flow of Funds statement has nothing to do with a 'cash flow' statement. A flow of funds statement shows how your assets and liabilities have increased or decreased between one period and the next. The point of it is to see where the 'funds' have come from (the 'source') over a period of time, and how they have been used. We can see this by comparing one balance sheet with another.

As an example, if your profit in year 1 was 10,000 and it is 15,000 in year 2 then we can see that it has increased by 5,000. This increase is looked at as a 'source' of funds. We then look further into the balance sheets to see how this source is being used. If you had an overdraft at the bank in year 1 of 2,000 and it had decreased in year 2 to 1,000 we can see that 1,000 of the source had been used to decrease the overdraft. Questions can now be asked as to whether or not this was a good use of your funds. This is an overly simple example. In practice, flow of funds statements are a good guide to the management of a business.

There are simple rules to follow to decide whether an increase or decrease in an account should be viewed as a 'source' or a 'use':

  • If a liability has increased (or an asset has decreased) it is seen as a source.
  • If an asset has increased (or a liability has decreased) it is seen as a use.

Remember that we are not looking at the current balance of an account, only the change of that balance between one period and the next. - Top

Q. What is a 'cash flow' statement?
A. A Cash Flow statement is a report which shows the flow of money in and out of a business over a period of time. A statement from your bank for your business's current account is a good example (although in practice, a cash flow statement would contain far more detail, eg. exactly what the money was being spent on). - Top

Q. What is a 'cash flow forecast'?
A. A Cash Flow Forecast is a report which estimates the flow of money in and out of a business over a future period of time. Like a cash flow statement (see previous answer) it will contain lots of detail as to exactly how you see your income and expenses increasing or decreasing. Its main point is to higlight future periods when your money supply may not match your outgoings, in which case you can budget ahead of time and ensure that a loan is made available should you need one. - Top

Q. What is 'journalising'?
A. A Suspense account is just another account in a double-entry system. It is usually used at the end of a financial year when a mistake has been found and a correction needs to be made but the accountant has no idea where the money has gone! A simple example will help: If the petty cash account has a debit balance of £100, but on checking the actual cash in the cash box only £90 remains, the accountant will add a transaction in the journal crediting petty cash £10 and debiting a suspense account £10 (to make the petty cash account balance with the actual petty cash). The suspense account can be given any name (ie. the word 'suspense' is used merely to describe the type of account), and in this case it will probably be called 'petty cash deficit' or something similar. Once the accountant knows where the money really went to, a correcting transaction can then be made to zero the suspense account and debit the correct account.

A suspense account is therefore an account used to finalise a set of books where the books cannot be finalised by normal means. For obvious reasons (especially if the amount is large) suspense accounts should be ruled off with a zero balance as soon as possible (eg. there could be tax implications if the suspense account turns out to be connected with the business's income). - Top

Q. How can I find out more?
A. Journalising is just another way of describing the act of entering transactions into a journal. - Top