It is well known that the double entry system of accounting is used by the majority of businesses. But sometimes small businesses and professions that cannot afford to hire qualified accountants typically use the single entry system of accounting. They just maintain a cash book and the personal accounts of customers and suppliers under this system. As a result, they keep only a partial and incomplete record of their transactions. This makes determining their company’s profit or loss and preparing proper final accounts difficult. In this blog, you shall be knowing some of the salient features of the Single Entry System and how it is used.
What happens under the “Single Entry System”?
The term “Single Entry System” is somewhat confusing. It appears that only one aspect of a transaction is recorded in books under this system. But this is not the case. In reality, the term “Single Entry System” refers to incomplete records or a defective Double Entry System. In this method, for some transactions, both the aspects (i.e., debit and credit) are recorded, while for others, just one side is recorded. And some transactions are simply ignored and are not recorded at all.
Consider the situation of a company that has a Cash Book as well as personal accounts for customers and suppliers. Whenever cash is paid to a creditor, it is recorded on the payment side (credit) of the Cash Book and debited to the creditor’s personal account. As a result, both sides of this transaction have been properly recorded, and the double entry is complete. The same is true for monies received from a debtor.
Similarly, when rent is paid, it is entered in the Cash Book, but no entry is made in the Rent Account because nominal accounts are not kept. As a result, just one aspect of this event has been documented in books, while the other is simply ignored. Because no fixed asset accounts are maintained, such firms make no entries for matters such as depreciation. As a result, the single entry system is a hybrid of double entry, single entry, and no entry. The accounts maintained by this system are insufficient and unorganized.
Thus, a single entry system is a system of book-keeping that does not follow any defined rules and that can vary from one organization to another. However, what stays common in this system is that organizations usually maintain only cash records and personal accounts of debtors and creditors.
Features of “Single Entry System”
Mentioned below are the most important features of the Single Entry System:
- A Cash Book is generally maintained under this system. However, it is very common to notice that the commercial transactions often get mixed up with the personal transactions of the proprietor.
- The personal accounts of customers (or debtors) and suppliers (or creditors) are kept if there are credit sales and credit purchases. The Real and Nominal Accounts, on the other hand, are ignored. In other words, no accounts for fixed assets, liabilities, expenses, or incomes are kept.
- One of the features of the single entry system is its variability. The implementation of this system is not uniform. It varies from company to company depending on their specific needs and convenience.
- To determine profit or loss or to gather information for any other purpose, relevant figures may only be obtained from original vouchers such as purchase invoices, sales invoices, and so on. As a result, reliance on original vouchers is unavoidable.
- The final accounts are not easy to produce. Only once the available information has been turned into double entry records and the missing values have been discovered can the Trading and Profit & Loss Account be prepared. Also, the figures for assets and liabilities derived from incomplete records are unreliable since they are based on estimations. As a result, the statement of assets and liabilities prepared at the end of the accounting period under this method is referred to as the “Statement of Affairs” rather than the “Balance Sheet.”
- This system is commonly used by small merchants, petty shopkeepers, doctors, lawyers, and other professionals. The system can be used by sole proprietorships as well as partnership firms. Limited companies, on the other hand, are unable to use it since they are required by law to keep complete records of all transactions, as well as those of assets and liabilities.
How are profits determined?
There are two methods to determine the profit or loss of a concern that follows a single entry system. One is the “net worth method” and the other is the “conversion method”.
The net worth method believes that the profit or loss for a year can be determined by any increase or decrease in the net worth (capital) of a business. For instance, an individual starts his business with a capital of $10,000 on January 1, 2021. On December 31 2021 when he closes his books, he finds that his capital has increased to $18,000. This shall mean that he made a profit of $8,000. Conversely, had the capital been $6,000 on December 31, 2021, it would have signified a loss of $4,000. However, bear in mind that this estimated profit/loss might need to be adjusted for additional capital brought or drawings made by the owner.
The net worth (capital) is calculated by preparing two separate statements of assets and liabilities (called “Statement of Affairs”) at the beginning and at the end of the year. The opening and closing capital are usually the balancing figures in such statements. For this purpose, you may get some figures of assets and liabilities from the accounts that are maintained, and for the rest, you have to rely on vouchers, supporting documents, and physical assessment. Cash and bank balances will be shown from Cash Book.
On the other hand, under the conversion method, it may be possible to prepare final accounts by converting the single entry records into the double-entry method. Here, various ledger accounts are prepared including sales, purchases, debtors, creditors, Trading A/c, and cash book. Due to the lack of complete information, the balancing figure in each of these accounts must be accurately understood. For example, if we know the opening and closing balances in the debtors’ accounts, as well as money received from debtors, the balancing figure will clearly reflect sales data. Furthermore, if we know the opening and closing balances of creditors and credit purchases, the balancing figure will almost probably be cash paid to creditors. Once these figures have been determined, it is simple to generate financial statements in standard formats.
In addition to its features, let’s have a look at some benefits of using the single entry system:
- It’s quick to set up and simple to keep up with.
- It is not necessary to hire a skilled accountant.
- This is especially useful for small businesses run by individuals where the level of activity is low.
- It is cost-effective because it does not necessitate extensive record keeping.
Even though it’s simple to maintain, the Single Entry System signifies the inadequacy and insufficiency of information. Therefore, it has some limitations, which are mentioned below:
- Because it is impossible to produce a Trial Balance in the absence of real and nominal accounts, the arithmetic accuracy of the books of accounts cannot be checked.
- Any information collected using this method will not be accurate and may be unreliable.
- It is not possible to prepare a Trading Account and determine the firm’s rate of gross profit. In the absence of a gross profit margin, the firm’s performance cannot be compared to that of other enterprises or to the past. This has an impact on proper planning and decision-making as well.
- True profit or loss, as well as information on assets and liabilities, cannot be obtained with certainty. As a result, the firm’s financial health cannot be assessed.
- In the absence of a proper and dependable balance sheet, the firm may be unable to secure various financial services from banks, such as overdraft or loan facilities.
- The system builds a culture of negligence and irregularity among employees, which can lead to fraud.
The single entry system significantly differs from the double entry system in the sense that it is only a convenient way of keeping books when the business is small. However, it is always a good practice to maintain a complete record of accounts to know the correct picture of profit or loss.
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