What Are the Different Types of Accounting Systems? Options Explained
There are two types of accounting systems: The first is a Single Entry System where a small business records every transaction as a line item in a ledger. The other is a Double Entry System, where every transaction is recorded both as a debit and credit in separate accounts.
A Double Entry System ensures a company’s books balance.
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What Is the Difference Between Single Entry and Double Entry?
A single entry system of accounting is usually used by very small businesses for its simplicity. Perhaps the business does not do a lot of transactions in a given day, or it’s a sole proprietorship and the owner does not require or have time for extensive bookkeeping. A single entry system is convenient, simple (no formal training is needed) and provides costs savings as it does not require complex software. A small business owner could run a single entry system of accounting on an excel program, if he so desired.
There are drawbacks to a single entry system. Due to the incomplete nature of the data entered, proper financial reporting is impossible. As such, it’s hard for the business owner to do a financial analysis and plan resources for the future. Errors are much more likely to go unnoticed and theft is less likely to be detected (because there is no asset inventory in place). Tax authorities do not recognize a single entry system of accounting for reporting purposes of any kind.
A double entry system is a much more detailed bookkeeping process, typically used by larger businesses. A double entry system will provide complete records and allows for the creation of proper financial statements. Errors are also quicker to detect. A double entry system of accounting paints a much more accurate picture of a company’s finances.
A double entry system is costly, often complex, and time-consuming. It is also subject to error too, if an entire transaction is not recorded there is no way for the system to know.
What Are the Types of Accounting Software?
Single Entry System
A single entry system does not require complicated software. An excel spreadsheet or something similar is all that’s needed to input the information. For instance, a single entry system transaction could look something like this:
Note that the ‘Expense’ column is empty. Because this was a sales transaction, the payment by the customer is considered “Income”. Had this business been paying a supplier instead, then ‘expense’ is where the amount payable would have been entered.
The ‘Balance’ refers to the overall cash balance of the company in its business bank account, once the transaction has been added.
Double Entry System
A double entry system of accounting does require software to properly manage it. Business owners should look online for software that is easy to understand (designed for business owners, not for accountants) and one that provides instant access to a number of reports, such as:
- Profit & Loss statement
- General Ledger
- Chart of accounts
- Sales tax summary
- Invoice summary
- Payment summary
- Expense reports
What Are the Types of Accounting Methods?
There are two types of accounting methods: Cash Accounting and Accrual Accounting:
Cash Accounting Method
Cash accounting records income and expenses as they are received and paid (when the money trades hands).
Accrual Accounting Method
Accrual accounting records the dollar amounts when a transaction (a bill going out or an invoice coming in) occurs, not when the cash is actually exchanged. An accrual accounting method is required by law when a business exceeds 5 million in sales. It is believed that this method of accounting gives a more accurate picture of a company’s finances.
These are the two main types of accounting methods, although sometimes companies are allowed to use a hybrid of the two, if certain conditions are met.
Which Accounting Method Should I Use?
Which accounting method you should choose depends on the size of your business.
Like a single entry system of accounting, a cash accounting method is preferred by small businesses because it is simple to implement and saves time. Because the transaction is recorded when cash exchanges hands, the business owner has a better idea of the company’s cash flow at any given time.
Accrual accounting is preferred by larger businesses (and in some cases, legally required) because it gives an organization a clearer picture of the company’s income and expenses. For instance, if combined sales for a company total 1.2 million in December, then an accrual system would show that amount in the company’s statements even if the payments from the clients didn’t come in until early the following year. Had senior management been going with a cash accounting method instead, they would be unaware of the 1.2 million and might make decisions or policy based on incomplete information.