The Accounting System
The accounting system converts raw financial transactions into useful information through five stages.
Five Stages
| Stage | What happens |
|---|
| 1. Source documents | Every transaction generates a document (invoice, receipt, bank statement entry) that proves it happened |
| 2. Books of prime entry | Transactions are sorted and listed chronologically in day books or the cash book |
| 3. Ledger accounts | Totals from books of prime entry are posted to T accounts using double entry |
| 4. Trial balance | All ledger account balances are listed — total debits must equal total credits |
| 5. Financial statements | Income statement and statement of financial position are prepared from the trial balance |
The Three Ledgers
| Ledger | Contents | Accounts it holds |
|---|
| Sales ledger | One account per credit customer | Trade receivables — amounts owed to the business |
| Purchases ledger | One account per credit supplier | Trade payables — amounts owed by the business |
| General ledger | Everything else | Assets, liabilities, income, expenditure, capital, returns |
Information Flow Summary
| Transaction | Source document | Book of prime entry | General ledger DR | General ledger CR |
|---|
| Credit sale | Sales invoice | Sales day book | Trade receivables | Sales |
| Credit purchase | Purchase invoice | Purchases day book | Purchases | Trade payables |
| Customer return | Sales credit note | Sales returns day book | Sales returns | Trade receivables |
| Supplier return | Purchase credit note | Purchases returns day book |
Key rule: Monthly totals from day books are posted to the general ledger. Individual customer/supplier amounts post to the sales/purchases ledger on the same day.