General Ledger System Accounts: Automated Accounting Systems are organized set of manual and computerized accounting methods, procedures, and controls to gather, record, classify, analyze, summarize, interpret, and present accurate and timely financial data from computerized systems. For any accounting system to work it needs to understand the distinction between balance sheet and profit and loss items. Automated systems also provide posting of certain special transactions to specified accounts. For these functions to work, seeded accounts types and accounts are defined in the automated systems. These mandatory pre-defined accounts and account types are referred to as “General Ledger System Accounts”.
Whenever IT professional starts working on any financial project, they encounters certain accounts and account types that are always seeded in the system, they are able to perform setups for those accounts after going through the manual of the software package, but usually explanation about the need and role of these accounts is not available in the product manual/guide . In this tutorial we will understand what are the minimum accounts types that need to be seeded in any financial system and "why" certain accounts have to be mandatory in nature before the automated accounting process can start.
In the later half we will discuss some special purpose accounts like Suspense Account, Clearing Account etc. and will focus our discussion on understanding what these accounts are and what roles these accounts play in an automated ERP system.
The intended audience for this tutorial is anybody who has a need to work on any financial IT system. This will be helpful to everyone who wants to understand how to design and implement effective automated accounting systems like ERP's. This tutorial focuses on these concepts from the perspective of an IT professional that is expected to work on any project involving design, build or interface to an automated GL system, rather than a student of accounting.
For Information Technology professionals this overview lesson relates important GL accounts to automated accounting systems and will help them understand the role these commonly used accounts play. This chapter will provide a foundation knowledge that will be helpful to IT implementers explain the future design and ERP functionalities to the end users more effectively. In the setup stages this will ensure that implementers understand the key differences between different types of accounts and they are able to classify client's financial data correctly.
During the requirements stage understanding of the system accounts will help professionals ask relevant questions to understand company's business processes creating needs for these system accounts. We recommend sharing the video and concepts of this tutorial with the super users before the requirements gathering session to enable an effective discussion on requirements around system accounts.
TechnoFunc is on a mission to create "Technology Independent Expertise".
The concepts presented in this chapter are conceptual in nature and they are applicable to all accounting systems irrespective of the underlying technology. Understanding of these concepts is perquisite to define and work on an automated General Ledger. This topic is beneficial to both IT professionals as well as end users. Persons seeking specialized accounting knowledge will also benefit from these discussions.
Mandatory accounts in GL can be classified into two broad categories – Fundamental Accounts and Special Purpose Accounts. In this part of this series we will focus on defining these account types and will explore the conceptual knowledge behind these accounts. During this tutorial we will be doing a deep dive into both account types, discussing individual accounts in detail.
Fundamental Accounts: Business operations may result in financial benefits or losses that arise as a difference of revenue gained from a business activity and expenses, costs and taxes needed to sustain the business activity. Any resultant profit or loss goes to the business's owner. Funds can be invested by owners or outsiders known as equity & liabilities and can be used to acquire assets to perform business activities. All general ledger accounts can be classified as belonging to either one of these categories – Equity, Liabilities, Assets, Revenue and Expenses. These are the fundamental account types from the perspective of automated accounting systems. Based on this classification, closing balances are never carried forward in automated GL systems for Revenue and Expense Accounts.
Special Purpose Accounts: Enterprise resource planning (ERP) systems integrate internal and external financial and non-financial information across an entire organization. Transaction flow happens between many inter-dependent processes and business units embracing finance/accounting, manufacturing, sales and service, customer relationship management etc. When one end to end transaction needs to be routed through multiple processes and modules, special purpose accounts helps in tracking financial flow and facilitates accounting reconciliation among different input and output transactional processes.
New category of accounts also classified as “Special Purpose Accounts” like Contra accounts, Intercompany accounts, Clearing accounts and suspense accounts etc. are defined to track the entire financial flow and identify and reconcile intermediary handoffs.
In any business that is going for large automated accounting systems, you can expect and large number of business transactions and parallel and sequential processes catering to different business requirements. Let’s try to understand some flows that are happening at all times:
Business Flows: The business has its own legal and physical structure. It deals in products or services and interacts with lots of third parties like suppliers and customers who interact with accounting systems while performing normal business transactions with the entity. If business transactions results in financial transactions, these business flows interact with the organization’s Accounting Flows.
Internal Process Flows: Company has its own set of rules, procedures and processes to perform business activities. Creating repeatable business processes is an important part of building and running an effective organization. Well-designed and documented business processes are critical for the success of business activities. These internal process flows also encompasses material flows. For example before releasing the material to end customer it needs to be moved from wholesale warehouse to retail warehouse. These process flows are for normal business activities and when these activities are financial in nature they interact with Accounting Flows.
Accounting Flows: For each of the processes whether they are internal or external, effective systems should automatically assist generation of accounting entries and track inventory, assets, liabilities and profitability of the organization. In these internal processes there is a need to break the accounting transaction into sub-transactions to identify and track these interdependent steps in these flows. For example when the material is received from the supplier, debit the inventory account and credit the AP Clearing Account (Because at that particular step, Payables Department has not received the invoice for the material received). Once the invoice is recorded in the subsequent Payables Process, clearing account can be netted off with the actual liability account.
This helps us understand how one single transaction needs to be routed through multiple processes and modules. These special purpose accounts helps in tracking financial flow and facilitates accounting reconciliation among different transactional processes as explained in our example for Inventory and Payables. These clearing accounts are classified as “Special Purpose Accounts” and are used to track the entire financial flow and identify and reconcile intermediary handoffs.