What are the source documents in accounting?
In order to complete the accounting records, a bookkeeper needs to have source documents to work from which show what the financial effect of the transactions is.
Types of Source Documents
The source documents themselves are introduced here. They come in many different shapes and sizes, but they can be split into three categories.
The key source document relating to credit sales made by the business is the invoice. When a business delivers goods or provides services and allows the purchaser time to pay (in other words, makes a credit sale) it will issue an invoice. This sets out the goods or services provided, gives the name and address of the purchaser as well as that of the supplier, states the amount that is due (separately identifying any VAT) and normally gives a date or time limit for payment.
But what if a customer complains that, although you have billed him for 1000 widgets, you only sent 900? The customer may issue a ‘debit note’, which formally sets out the shortfall and the amount that the customer thinks should be offset against the bill. Whether he does or does not issue a debit note, your response (if you think the complaint is justified) is to issue a credit note. This looks like an invoice, but states that the amount owing to you by the customer is to be reduced by the amount shown.
You may well have encountered credit notes when shopping, if you take goods back. Here you have already paid for the goods, so the credit note is money which can be taken off your NEXT purchase. In the business world, most of the time the credit note is raised BEFORE the bill is paid, so the amount is taken off the amount paid for the CURRENT purchase. The principle, however, is exactly the same.
On a practical level, the original invoices and credit notes are of course sent to the customer. You may be working from a copy, or in some cases simply from a computer listing of transactions within the accounting system. You should also note that the seller may send out monthly statements of the amount owing, or reminders for overdue invoices; these should not be confused with invoices, even though they may look similar.
A business which sells mainly for cash may still prepare invoices, or receipts which are very similar to invoices. For most retail businesses, however, the source document which accountants will work from is the till roll. This shows the total amount taken in for goods and services, whether by cash, cheque or card.
In a very small business which buys everything for cash, the only record of a purchase will be the till receipt for payment. If the payment was made by cash, there may also be a petty cash slip. However, larger businesses need a more formal system to ensure that purchases are authorized by the right person and that payment for the goods is only made when they have been received and checked.
Assume that the Maiden Megastore is ordering 5000 CDs from Acme Artistes:
- A purchase order is prepared by Maiden Megastore — a form that is sent to Acme Artistes setting out the 5000 CDs to be supplied and the price to be paid (already agreed between the companies). This has to be authorized at an appropriate level of management within Maiden.
- Acme sends the 5000 CDs, and at the same time encloses a ‘Dispatch note’ giving the details of the shipment. This will be checked against the order and approved by Maiden.
- Acme then sends an invoice to Maiden for the agreed price of the 5000 CDs.
- Maiden checks the invoice against the purchase order, and may also check it against the dispatch note. The aim is to ensure that the goods were genuinely ordered, and have been received. A failure in the system at this point would mean that an unscrupulous trader could simply issue invoices for non-existent goods or services to businesses taken from a trade telephone directory and get paid! If there have been any problems with the shipment, debit and credit notes may be issued.
- Finally (and possibly after Acme has had to issue a statement of the account, see above) Maiden sends Acme a cheque for the amount owed, often using a payment slip that can be torn off the invoice. It is not normal in business for Acme to then issue a receipt for the cash received if it was in response to an invoice. Acme will enter the payment against the amount owed by Maiden, leaving nothing outstanding, and will pay the cheque into the bank.
Note that the purchase order and dispatch note are not records from which accounting transactions should be entered, since they do not create or satisfy financial obligations. They are useful when calculating accruals (these are operating expenses owing at the end of a period) for final accounts, but the main reason for including them here is to alert you to their existence so that you do not confuse them with other documents.
The final category of source documents used to create the accounting records is banking documents. Most of these will be familiar from your own personal banking.
The bank statements are crucial to the preparation of accounting records. They may be the only record of some transactions, such as payments made direct into the bank account of a supplier by a customer through the banking system (a ‘BACS’ transfer). In other cases, they will summarize the information that is available elsewhere.
Payments made by cheque will generate two different records. The customer should have a completed cheque stub (often called a counterfoil) in the cheque book. The supplier should have a completed paying-in slip stub/counterfoil in the paying-in book, showing the payment of the cheque into the bank. Sometimes cheques are not honoured by the customer’s bank (called dishonoured). They will then be returned to the supplier who paid them in, marked ‘refer to drawer’.
If you look back at the example of Maiden and Acme, you will see that when Maiden first received the cheque from Acme this was entered into their accounting records, with the result that Maiden is now shown as owing nothing. If the cheque is returned not honoured it has proved to be worthless, and another entry reversing the payment will have to be made in Acme’s books so that Maiden is once again shown as still owing the money due for the 5000 CDs. A similar adjustment will have to be made in the books of Maiden to reflect the fact that they still owe Acme the price of the CDs.