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Manual accounting systems are primarily a relic of the time before computers. Transaction records are maintained by hand on a ledger, four-column accounting paper, or notebooks instead of being digitized with accounting software or the numerous apps and web-based accounting solutions out there today.
Why would someone still utilize this method?
Can ledgers be digitized easily?
Here’s what you need to know about manual accounting systems and their place in the 21st century.
Benefits and Disadvantages of Manual Accounting Systems
One of the chief drawbacks of a manual accounting system is that they are rife with potential for errors. While human input in a computerized accounting system can also create errors, be they in transaction amount or spelling as both have impacts, manual accounting systems are inherently more prone to errors. It’s easier to misplace numbers into the wrong column or enter amounts incorrectly if they are being copied from transaction records by hand. If additional calculations need to be performed, this requires doing the math mentally, with pen and paper, or an adding machine or calculator and presents more opportunities for errors in both input and output.
While computerized accounting solutions aren’t completely foolproof if numbers are transposed or entered in duplicate, they are programmed with various safeguards such as not letting journal entries post if the total debit and credit amounts are unequal. Additionally, depending on what accounting solution is being used, some can integrate with payment processors, bank accounts, and other financial and ecommerce accounts to maintain accuracy and reduce the amount of time spent manually entering transactions. Manual accounting systems are much slower, and more time-consuming to manage as each transaction needs to be entered by hand with no copy and paste functions.
As manual accounting systems evolved, singular ledgers and notebooks began to be replaced by multiple journals:
• Cash receipts journal
• Cash disbursements journal
• Sales journal
• Purchases journal
• General journal for all other transactions, and for adjusting and closing entries
Computerized accounting systems eliminate the need for multiple journals and consolidate all accounting data in one place. However, people still opt for manual accounting systems because if they have rudimentary accounting knowledge and a very low transaction volume, a ledger can be just as accurate as a computerized file. There is comparatively little upfront cost in setting up a manual accounting system compared to purchasing software or subscriptions, which makes it ideal for small businesses that run on tight budgets and don’t have many transactions to record. If the user also has little or no accounting knowledge, it’s easier to record transactions in a ledger than use an accounting program that is likely to be incorrectly set up. Ledgers and accounting paper already have designated columns and marks for using them correctly.
Manual accounting systems also provide instant access to financial records without needing to look for specific receipts, invoices, and other records. Opening a ledger is possible any time, and is not dependent on power and Internet being available. Paper records also have an advantage in that they can’t be hacked online. However, ledgers can also be stolen, lost, accidentally thrown out, or damaged in accidents and natural disasters.
Ultimately, it’s more difficult to manage financial records on paper when computerized systems offer more options for readability, accessibility, integration, duplicating transactions, and providing a native mathematical function for checking that journal entries are balanced. If the equation is not balancing, the numbers need to be examined thoroughly and recalculated repeatedly until the trial balance computers correctly. While this action needs to be performed with computerized accounting systems as well, computerized systems have search functions to find transactions that human eyes are likely to miss.
If transaction volume starts to increase, manual accounting systems become far less tenable.
Steps in Converting Manual Accounting Systems to Computerized
Step #1: Select an Accounting Solution
Business owners who pivot from manual accounting systems to computerized systems first need to research different accounting platforms and subscriptions to determine which one is best for their needs. While most of the well-known accounting programs are designed to be versatile for all types of businesses, a business with inventory is going to have different needs than a business that is strictly service and may need to try multiple solutions. Web-based accounting has appeal for business owners who travel frequently, but a desktop program will function if the Internet is out.
Step #2: Finalize the Manual Accounting System
Once an accounting solution has been decided upon, the data in the manual accounting system needs to be verified and finalized so that when it is entered in the new system, all of the records and calculations are correct.
Step #3: Set up a Chart of Accounts
After the transactions have been verified, a chart of accounts should be set up within the program. If a chart of accounts already exists for the manual accounting system, it can be transferred with the same naming and numbering conventions. If not, a new one must be established. Most accounting programs provide templates based on the type of business, such as a bakery or independent consultant, and they can provide a good guideline if you are unsure how to manually set up a chart of accounts from scratch.
Step #4: Transfer Ending Balances from Manual to Computerized System
Once the chart of accounts has been set up in the program, the ending balances from the verified account data in the manual system can be transferred. These entries should specify the account name and number, type of account, and beginning balance. After each entry, compare the new beginning balances to the ending balances in the manual accounting system and make sure both balance out.
Step #5: Run Both Systems parallel for a Transition Period
To ensure a smooth adjustment, both the manual and computerized systems should be used parallel for a temporary transition period (such as one or two months). This helps ensure that the computerized system is working as intended. Eventually, the manual system is completely discontinued and the records can be archived or destroyed as needed.
How to Set up a Manual Accounting System
New and very small businesses may still opt for manual accounting systems if they are not yet ready to invest in a more robust computerized solution. After all, pen and paper records cannot be hacked or become inaccessible if there is no power or Internet.
The following steps should be taken to set up a manual accounting system:
Multiple journals, or separate tabs in a larger ledger, should be on paper with columns. Typically, they are light green or have contrasting colors for rows and/or colors to help separate debits and credits.
Regardless of whether single or multiple journals with accounting paper are used, the columns are tallied and these journal entries are carried to the general ledger (a separate pad with similar columns and layout). Multiple journals and the general ledger can be kept as separate literal books, or in separate binders if not one larger binder separated by tabs.
Regardless of how these paper records are organized, users should be able to easily find the transactions they are searching for instead of spending inordinate amounts of time searching for the right page.
The journals, if using multiple journals, and general ledger should have running totals. For instance, the year-to-date totals for rent and utility expenses would be in the general journal and the cumulative sales balance would go in the sales journal, so that users would have these numbers on hand easily without having to manually calculate them every time the books need to be referenced.
Many small business owners also use their business checkbooks in lieu of purchases and disbursements journals, and this will also suffice.
Dates are also incredibly important. While they are equally crucial in a computerized accounting system, they are even more important with manual accounting systems. The first column on a ledger page or piece of accounting paper is typically reserved for dating transactions. Date ranges are critical for reconciliations, trial balances, financial statement compilation, and tax form preparation. Users need to be fastidious about entering and checking dates just as they would with transaction types and amounts, in order to easily check and trace transactions back to journals and corresponding documents like bank and credit card statements.
Once the page has been filled with transactions, all of the columns need to be tallied and have the totals written on the next page in order to keep booking transaction. Every page should also be identified with the name of the journal or ledger, and have page numbers written in if they were not provided.
Manual accounting systems are becoming less common as accounting and recordkeeping functions move into the digital age. The most prominent advantage is that manual accounting records cannot be hacked or compromised online, and can be accessed regardless of power and Internet outages. However, the most major drawback is that manual accounting systems are incredibly time-consuming and prone to errors. One cannot copy and paste text, dates, and amounts by hand and a computerized accounting system becomes more of a necessity as transaction volume and complexity increase as the business evolves. New businesses that are operating very leanly are likely to start out with a manual accounting system to save money while transaction volume is extremely low, and it is possible to switch to a computerized accounting system as the business grows.
When deciding which accounting system is best for your business, all types of risks and benefits need to be considered along with the type of business that it is. Small service businesses with simple transactions and low volume may still get by with a manual accounting system in the 21st century, while an inventory-heavy business that is quickly growing is going to need a computerized system much faster. Some businesses also utilize hybrid accounting systems so that records can be accessed regardless of power and Internet outages, and reduce the risks of data corruption and hacking.
Disclaimer: Please keep in mind that the content of this post is not intended as tax, accounting or legal advice. The information presented here is for informational and educational purposes only. Before engaging in any transaction, be sure to discuss these matters with a trained, licensed professional.