How to record your business's accounting transactions

Many entrepreneurs share the common trait of operating their business without taking into account basic accounting information, which is the same as walking blindfolded. They settle for having a record of income and expenses or just knowing how much money they had left at the end of the day or the month. If it is not enough, they lack reliable records to correct many problems.

The belief that only common sense is needed to handle the accounting of a business is a big mistake. In reality, it is indispensable to use an accounting system that will make it possible to make correct decisions and thus avoid hasty actions that could lead to failure.

Status of private businesses in Cuba

There are varied ways to classify a business, but no definition can capture all the dimensions of a small- or medium-size business. Many of the definitions regarding size are based on metrics such as number of employees, balance sheet results and annual revenue.

One concept is that of the micro-enterprise, which refers to a business that includes from one to five people with only one owner and that engages in simple activities managed on a one-to-one basis. In the majority of cases, they have only one product (good or service) or one type of operations with low levels of invoicing and expenses and no major credit transactions, meaning they do not devote a significant amount of time to accounting.

A small business, for its part, refers to a business that employs between six and 50 employees, has several lines of activities and more than one location, and in addition incurs loans and has a payroll. In most cases, its revenues and costs are analyzed by product line. Also, a significant portion of its activity is conducted using credit, wherefore using an accounting system becomes a necessity.

In Cuba, self-employment activities that have been approved may be classified as micro-enterprises or medium-size enterprises, even in cases where self-employment work (TCP) falls into the two legally approved categories: simplified system or general system, according to the number of workers hired, size of the business or annual revenue earned.

Whichever way the term is used to classify them, they have a common trait: most of those businesses do not set work strategies, their technology is simple and productivity is low and they have limited capital with little access to financing, and, in addition, they do not have accounting records or an accounting system.

Pursuant to Law 113 dated July 23, 2012 on the Tax System, section two of the accounting system, Article 58, TCPs who earned an annual income equal to or greater than one hundred thousand Cuban pesos (100,000.00 CUP) during the previous fiscal year use the accounting system established by the Ministry of Finance and Prices.

Specific accounting standard No. 1 for filing financial statements for cases of self-employment stipulates the regulations allowing to apply a simplified accounting system for earned amounts, closely related to cash transactions.

According to this standard, the accounting system utilizes the historic cost as a base measurement. The records to be used as the source for financial statements are the general ledger, the operation vouchers ledger and the income and expense ledger. Additionally, the source for the income entries is the income and expense ledger.

Although according to the law the simplified accounting system must be applied to a series of TCP activities, many entrepreneurs feel no need to implement it, in addition to there being no strict compliance with and control of the use thereof by the responsible bodies.

For proper business development, establishing accounting controls is fundamental to be able to identify the strong and weak points for managing services rendered or in manufacturing a product, regardless of the size of the business. Following this line allows entrepreneurs to better position their business with regards to potential suppliers of raw materials and financial resources.

Accounting, accounting subsystems and accounts

Accounting is the language used to represent the daily transactions that take place in a business. To carry out the company’s accounting process, there is a subsystem of input flows to compile all the data of transactions that have taken place in a given period. Subsequently, during the process itself, those operations are analyzed, classified and recorded, thereby creating the financial statements (balance sheet, income statement and cash flow statement), to then analyze said information. At the end, as output flow of the process, the financial statements are submitted.

From this point of view, a transaction is any event that affects at the same time the business’s financial position, that can be reliably recorded. In other words, the transactions that are recorded are those whose monetary amounts may be reliably measured.

Every business or enterprise starts off with an inventory called the initial inventory; i.e., a detailed list of the company’s assets and liabilities at the commencement of its business activities.

Accountants measure the business’ activities and process the data to prepare the financial statements. Their basic tool is the accounting equation (assets = liabilities + capital).

Each of these groups may be called financial assets and liabilities. To record activity and transactions it is not necessary to use financial assets and liabilities because the information they provide is not concrete. For this, accounting uses accounts.

An account is the means or instrument in accounting transactions whereby we can subdivide assets, liabilities and capital and group them together according to certain common characteristics that will allow us to represent each increase and decrease that occurs in the different components of the accounting equation, in addition to the entity’s income and expenses. Accounts are divided into real, nominal (results) and closing accounts.

When an accounting system is set up, codes are created for previously organized, classified and numbered accounts. This code makes it possible to organize the accounts in the general ledger, which facilitates going to the accounts and also doing an orderly trial balance.

Recording of accounting transactions. Accounting books (journal and general ledger)

Activity or entries that take place are recorded in the accounting books, which are used for the following purposes:

To comply with the legal provisions mandated by the Commercial Code, the Tax Code and other rules and regulations, because they grant the legal right to exercise rights and comply with labor obligations with third parties.
To reflect the company’s financial and economic situation, thus giving a sense of security to the company’s creditors and debtors.
To record and monitor the company’s income and expenses, which makes it possible to safeguard equity.
To leave a written record of transactions carried out, while at the same time keeping them in chronological order.

Accounting ledgers include journals and general ledgers. The former pertains to a basic accounting technique where each type of account follows a pattern in its activity. Every transaction happening in a company is recorded therein in chronological order, indicating the names of the accounts to be debited and credited, as well as the amount of the debits and the credits.

The characteristics of the journal are as follows:

Consecutively numbered (chronological dates).
Debit accounts, which record debits (debit side).
Credit accounts, which record credits (credit side).
Annotation (brief explanation of the business transaction being recorded).

When adding up the debit and credit columns, totals must always be equal to comply with the double-entry accounting principle. Annotations that are recorded in the journal are called accounting entries or items. There are two types of entries: simple, which consists of a debit account and a credit account, and compound, which consists of one or more debit and credit accounts.

After making the entries in the journal, there is a general ledger for each account that appears in the journal. It consists of a mandatory ledger that must be kept by every business, since it groups together the assets, liabilities, capital, income and expense accounts. Each entry made in the journal is immediately transferred to the general ledger, which records each account’s activity and, at the end of the period, shows the balance yielded by each of them.

Annotations on the left-hand side (debit) of the journal are posted on the debit side of the pertinent general ledger account, and annotations on the right side (liabilities) are posted on the credit side of the pertinent general ledger account.

In practice, there is a general ledger into which journal transactions are transferred. It is represented with a simple T-chart for each account showing the debit entries and the credit entries. Assets accounts increase for the debit side and decrease for the credit side. If there is a balance, it will always be a debit balance. Liabilities and capital accounts increase on the debit side and decrease on the credit side. If there is a balance, it will always be a credit balance. Income accounts increase on the credit side and expense accounts increase on the debit side.

DEBIT

CREDIT

Increases in assets.

Decreases in liabilities.

Expenses activity.

Decreases in assets.

Increases in liabilities.

Income activity.

Source: Prepared by the author himself.

Journal example:

Source: Prepared by the author himself.

Recommended bibliography:

Contabilidad Financiera 1: Introducción a la contabilidad. Editorial Félix Varela, Havana, 2004.
Cañibano Calvo, Leandro: Teoría actual de la contabilidad. Técnicas analíticas y problemas metodológicos. Published by ICAC, Madrid, 1997.
Decree No. 308. October 31, 2012 Reglamento de normas y procedimientos del Sistema Tributario. Council of Ministers.
Elementos de Contabilidad. Selección. Editorial Félix Varela, Havana, 2005.
Guía del cuentapropista. Finanzas al día 1. Empresa Gráfica de Finanzas y Precios, Havana, 2012.
H. A. Finney: Contabilidad general. Editorial Hispano-americano, Mexico, 1965.
Law No. 113. July 23, 2012. Tax System. National Assembly of the People’s Power.
Maldonado, R: Estudios de la contabilidad general. Editorial Félix Varela, Havana, 2006.
Torres de la Luz, Oscar: La contabilidad: una ciencia al servicio de la dirección, Havana, 2004.
Resolution No. 386/11 MFP and exhibits