Bookkeeping is the systematic process of analyzing, recording, and summarizing the economic transactions of a business or other organization. Organizations and individuals use bookkeeping because it provides orderly and accurate information about their financial transactions.
Bookkeeping is closely related to accounting. Bookkeeping deals mainly with analyzing and recording financial information. Accountants do these activities but also design and install information systems, perform audits, interpret financial statements, and prepare tax returns.
The type of bookkeeping system an organization uses is determined by such factors as the size and nature of the organization and the different kinds of reports that must be prepared. Most small businesses have simple bookkeeping systems, but large organizations usually need more complex systems. Bookkeepers often use computers to prepare such items as invoices, customer statements, payrolls, and checks. Many organizations have completely computerized their bookkeeping and information systems.
Bookkeeping records and procedures
Accounts.
Bookkeepers record all economic transactions in accounts. The three basic types of accounts are asset accounts, liability accounts, and equity accounts. There are also income (or revenue) accounts and expense accounts.
Assets are the resources used by an organization. An organization usually owns its assets, which include cash, inventory, supplies, land, buildings, and equipment. Separate accounts are kept for the various types of assets. Liabilities are claims of creditors, such as debts owed by an organization. They include accounts payable, wages payable, and mortgages payable, and they are generally recorded on separate liability accounts. Equity consists of the claims of owners. Such claims include contributed capital and retained earnings. Income and expense accounts are sometimes called nominal accounts. They are considered part of the equity of the organization.
Double-entry bookkeeping.
The most common bookkeeping system is called double-entry bookkeeping. This system looks at two dimensions of every business transaction. Thus, every account has two sides. One side is the debit side, and the other is the credit side. Each side has columns for dates, explanations of any changes in the account, and the amount of money involved.
For asset accounts, the beginning balance and all increases are recorded on the debit side. Decreases are recorded on the credit side. This procedure is reversed for liability and equity accounts. That is, the beginning balances and all increases are shown on the credit side, and any decreases are recorded as debits.
Most transactions in income accounts are reflected as credits. Most transactions in expense accounts are debits.
The fundamental equation in double-entry bookkeeping is Assets = Liabilities + Equity. A transaction can affect this equation in many different ways. But the two sides of the equation must always balance each other—that is, they must be equal.
Some transactions increase—or decrease—both sides of the equation. Others affect only one side. For example, the purchase of a machine for $100 in cash will affect only one side, the assets side. This is because the purchase will increase the equipment account, an asset account, by $100 and decrease the cash account, also an asset account, by $100. However, the purchase of a machine for $100 on credit will increase both sides of the equation, the assets side and the liabilities side. This occurs because the purchase will increase the equipment account, an asset account, by $100 and will increase the accounts payable account, a liability account, by $100. In principle, bookkeepers analyze every business transaction in this manner. That is, they check to determine what changes a transaction has caused in the organization’s assets, liabilities, equity, income, and expenses.
Many kinds of transactions and events are relatively easy to analyze. But difficult questions may arise in deciding what accounts to debit and credit. For example, there has been disagreement about the proper method of recording an oil company’s exploration costs. The pensions earned by an organization’s employees also cause bookkeeping problems. Such issues are generally discussed and debated by accountants, not bookkeepers.
Bookkeeping and financial statements.
At the end of a specified period, such as a month or a year, bookkeepers determine the actual balance in each account. They do this by taking each beginning balance, adding increases, and subtracting decreases. The balance in each account is then listed in a record called a trial balance. All debit balances are shown in one column and all credit balances in another. Unless an error has been made, the sum of all debit balances equals the sum of all credit balances.
Accountants prepare four financial statements: the balance sheet, the statement of income, the statement of cash flows, and the retained earnings statement. The balance sheet shows the totals from the various asset, liability, and equity accounts and thus reflects the organization’s financial position at a given date. The statement of income, based on the totals for incomes and expenses, reflects the organization’s profitability over a given period. The statement of cash flows reports the sources and uses of cash in the organization’s operating, investing, and financing activities. The retained earnings statement shows the amounts and causes of changes in the organization’s retained earnings.
History
Scholars have traced the origin of double-entry bookkeeping to Italy, where merchants used the system during the 1300’s. The first known explanation of double-entry bookkeeping appeared in 1494 in Summa de Arithmetica, Geometria, Proportioni et Proportionalita, a mathematics book written by the monk Luca Pacioli and published in Italy.
The first American bookkeeping text was A New Complete System of Book-keeping by an Improved Method of Double Entry (1796), written by William Mitchell and published in Philadelphia. Another important step in the development of bookkeeping in the United States occurred in 1880 with the publication of “The Algebra of Accounts,” a series of articles by accountant Charles E. Sprague. By the early 1900’s, the subject of bookkeeping was included in the beginning chapter of many accounting texts. Since then, bookkeeping has been taught in high schools and vocational schools. Many students also learn the principles of double-entry bookkeeping in basic accounting courses in college.
For many years, banks, churches, hospitals, political parties, retail stores, and other organizations employed bookkeepers to help keep records of financial transactions. But since the late 1900’s, organizations have increasingly depended on computers for the operation of bookkeeping systems. Today, most companies have accounting information systems that keep track of the results of business activities.
