Simple accounting system can be likened to cash accounting, this is an accounting system which states that you only account for a transaction that has cash impact there and then. Under the simple accounting system, if the transaction does not impact cash it does not make sense to you. For example, if you are into baking business and you bought sugar on credit when you are accounting for your expenses in the day you will not include the sugar under the simple accounting system. If you bought flour and you paid cash for it and you also paid for wages, these will be accounted for under the simple accounting system.
The simple accounting system is the opposite of the accrual accounting, under the accrual accounting method you do not only think about cash and this is what we are mostly confronted with in the business world today. Accrual accounting includes cash and credit transactions and in line with International Accounting Standards, financial statements should be prepared on an accrual basis.
The key indicator here is time, during that period have I sold and you also have to determine whether it was a cash or credit transaction. Remember that we have four (4) types of financial statements: Statement of Financial Position, Income Statement, Statement of Cash Flow and the Statement of Change in Equity. Our statement of cash flow deals strictly with our cash transactions and near cash transactions that it is a transaction that can be converted easily to cash while under the income statement, revenue can be earned even if the customer has not paid fully which is called accrued revenue for example, our credit sales transactions. Hence, you can earn revenue even though your customers may not have paid you for your services also you can incur expenses even though you have not yet paid for the expenses you incurred such as utility bill.
In today’s world, the default transaction is credit expect it is otherwise stated or specified. For example: I bought a laptop from Henry, the default assumption is that the transaction is a credit transaction expect it is qualified as a cash transaction. There are some terminologies that can help us identify that the transaction is a cash transaction such as contribute, collection or payment they all depict cash transactions.
We remember our fundamental equation in accounting which is Assets = Liabilities + Owner’s Equity, it is important to note that this equation remains like this until a transaction takes place that moves it to another snap shot.
Rules of the T account
The rules governing the T account is the conventional rule in accounting. Which states as follows:
- When your assets are increasing, you must enter it into the debit side of the transaction. Hence, all your items on the assets side once they are increasing you record it as a debit transaction.
- When your assets are decreasing, you must enter it into the credit side of the transaction.
- The opposite of what happens to the assets is what happens to the liability and owner’s equity, when a liability or your owner’s equity is increasing you will enter it into the credit side of the T account.