Under this discussion, we are going to build up a conversation on steps to be followed when a sole proprietorship starts to adopt a double entry system. Sole traders are the simplest form of business organization to be formed.
So the following steps are the basic steps to be followed by a sole trader when moving towards a double entry system.
1. Choosing the accounting method
When it comes to accounting method there are mainly two accounting methods that can be adopted. They are;
- Cash basis
- Accrual basis
Cash basis means you record whatever the amount you received and paid. In simple terms, you recognize a receipt as an income when you receive a payment from a customer and you recognize a payment as an expense then and there you make a payment to a supplier.
Accrual basis means you record in the books the amount that you should pay and that you should receive for a particular period. Here regardless of you actually received it or not, actually paid it or not the amount due is recognized as the income or the expense for a particular period.
So choosing this accounting method is one of the important tasks as this decides the amounts to be recorded.
2. Deciding the method of recording
In this phase, you got to decide as to whether you are going to record the transactions by your hand as they are occurring, whether you are going to do it in a more professional way by way of hiring an accountant or using accounting software.
This method of recording the transactions depend from one sole trader to another as different methods include different drawbacks and their own advantages. If a particular method’s benefits exceed the cost of that specific method, the respective sole trader might go for that method.
As a sole trader if you are going to record the transactions by your hand then it takes a small cost but it takes huge administrative efforts as it needs more paper workings.
And if you are going to hire an accountant, the cost is comparatively higher than recording transactions by your hand. But the responsibility of the bookkeeping along with the maintenance of the accounting papers will be fully undertaken by the accountant.
The other method is using software which is the most costly method but the easiest method out of all. As a sole trader if you have the capacity you can go for this method under which the software takes the responsibility of the bookkeeping task.
3. Keeping and maintaining all the source documents
After you are done with deciding the accounting method and the method of recording, the next step is to maintaining and keeping all the source documents in a proper manner so that you can support each and every transaction to be recorded in the books of entries. This has to be done in a very proper manner in a way where you are capable enough to support any transaction regarding its occurrence.
4. Posting the transactions into the ledger and summarizing income and expenses on a periodic basis
Now as the transactions occur you got to post each and every transaction on to the ledger. When posting a transaction on to the ledger each transaction has two entries which are known as Double-entry bookkeeping system. Followings are the double entries for different types of common transactions.
The above-mentioned entries are the common double entries which should be followed when posting the transactions to the ledger.
Once the transactions are posted into the ledger you got to summarize your income and expenses on a periodic basis. It could be daily, weekly or monthly depending on the frequency of the transactions of the business. Higher the frequency of the transactions the higher the frequency of summarizing.
For example, suppose you have decided to summarize the transactions daily. Then at the end of each day, you got to summarize your income and expenses.
5. Creating basic financial reports
For the sake of reporting transactions and summarizing them, it won’t give any idea about the performances of the business. Therefore you got to create financial reports so that you can do the predictions of the future financial performances of the business. At this phase, you are almost done with half of the accounting works where you only have creating basic financial reports. In accounting, there are mainly 5 types of financial reports.
- Income statement
- Statement of financial position
- Cash flow statement
- Statement of changes in equity
- Supporting documents
Those are the main financial reports that the business should finally come up with. And the outcome of each report guides the sole trader to come up with the conclusions of the performances of the business. And even provide guidance to predict future financial performances.
When moving towards a double entry bookkeeping system there are different steps to be followed and those steps were discussed in detail in the above discussion. In a nutshell choosing the accounting method, deciding the method of recording, keeping and maintaining the source documents, posting the transactions and summarizing the income and expenses on a periodic manner, preparing financial statements are the main steps in that process.