The Design of Accounting Systems
The accounting system is essentially a database of information about business transactions. The primary use of a database is as a source of information, so the accounting system needs to be designed in a manner that is cost-effective in providing the needed information. The key factors in accounting system design are as follows:
- Single or double entry. A very small business operates simply by recording cash receipts and payments in its checkbook. This is known as a single entry system, and is only adequate when a business owner has no interest in learning about the amount of the assets and liabilities held by a business. The single entry system is extremely simplistic, but can be adequate. The double entry system is designed to record not only sales and expenses, but also assets, liabilities, and shareholders' equity, and so provides considerably more information. The double entry system requires more skill in recording transactions, and is used by all larger organizations.
- Cash or accrual basis. The cash basis of accounting only records transactions as cash is received or spent, while the accrual basis records transactions when they should be recognized, irrespective of changes in cash. The accrual basis is needed to be compliant with any of the accounting frameworks, such as Generally Accepted Accounting Principles or International Financial Reporting Standards. If you expect to need audited financial statements in the future, use the accrual basis of accounting.
- Account code structure. The account code structure is the numeric or alphanumeric designation given to each account in which information is stored. A lengthy account code, such as one with seven or more digits, allows for a great deal of specific record keeping. However, it also requires more work to maintain, and there is a higher risk that information will be incorrectly coded into the wrong accounts. Thus, it is generally best to keep the complexity (i.e., length) of the account code structure to a minimum. Smaller organizations may find that as little as a three-digit account code structure is sufficient for recording information, while larger, multi-division entities may require considerably more complex code structures.
- Accounts used. You must decide which accounts to create. At a minimum (for a double entry accrual system) you will need accounts for cash, accounts receivable, inventory, fixed assets, accounts payable, accrued liabilities, equity, revenue, cost of goods sold, and administrative expenses. However, even a smaller business needs several times this number of accounts in order to keep adequate track of its operations. In particular, it will likely be necessary to maintain a number of different expense accounts, in order to more closely examine expenses.
- Divisional representation. A larger business may adopt a standard set of accounts and replicate them for each of its subsidiaries. This may also be necessary for individual product lines or facilities. This level of fine-grained detail is especially common when a business operates an activity-based costing system.
- Reports. The information stored in the accounting system must be aggregated into a system of reports that are used either to present the financial results and position of a business, or to provide more specific reports of financial results. Many of these reports are prepackaged with accounting software packages, though a business may have special needs that call for custom-designed reports.
- Procedures. An accounting system is not operational until there are a set of procedures in place that show users how the system is to be operated. The more common of these procedures are usually documented in some detail and imparted to employees through formal training sessions.
- Controls. A number of accounting controls are needed to ensure that an accounting system operates in the manner intended. These controls will be specific to the company, and may call for the participation of the company's auditors or an outside consultant to ensure that the set of controls installed are appropriate for the operations of the business.
Many of the issues just noted are so fundamental that you must get them right from the start, or be in danger of having to rebuild the entire accounting system at a later date to accommodate whatever changes are needed. In particular, it is best to immediately adopt a double entry bookkeeping system and accrual accounting.