What Is Double-Entry Accounting?
Double-entry accounting or double-entry bookkeeping is an accounting method often used by businesses to lower the risk of mistakes and enhance the accuracy of company accounts. In this informative article, we’ll discuss how double-entry accounting works, why it’s beneficial, and take a look at some examples.
What Is Double Entry Accounting and How Does It Work?
The fundamental concept of double-entry accounting is based on recording transactions in two accounts. Every transaction is both debited from one account and credited to another to maintain accurate balance sheets.
Since a debit in one account reflects a credit in another, using the double-entry system offers a way to easily check for missing or incorrect entries, thus providing additional protection from mistakes for businesses and organizations.
When utilizing double entries, accountants and businesses track transactions, providing information about each transaction to balance company accounts.
Transactions are financial events: making or receiving payments to and from clients or vendors. Business transactions are usually categorized according to seven types of accounts:
The purpose of bookkeeping is to monitor and record changes in accounts.
Single-Entry vs. Double-Entry Accounting
When analyzing accounting methods and exploring the benefits of double-entry systems, it’s beneficial to compare double-entry accounting to the single-entry system. Here are the key differences.
- Tracking: Single-entry accounting tracks revenue and expenses. Double-entry accounting tracks revenue, expenses, assets, liabilities, and equity.
- Entries: Single-entry involves making one entry per transaction. Double-entry means making two entries per transaction.
- Mistakes: Double-entry accounting is used to lower the risk of mistakes and is considered a more accurate process than single-entry bookkeeping.
- Procedure: Single entries can be done using spreadsheets or pen and paper. Accounting software is generally recommended for double-entry accounting.
- Scope: Single-entry accounting provides information about profits and losses. Double entries offer more information about the financial health of the business.
- Suitability: Single-entry systems may be best for freelancers, sole traders, and businesses with very limited assets and liabilities. Double-entry accounting is beneficial for all businesses with significant assets, liabilities, and inventories.
Single-Entry Accounting Example
To highlight the difference between single and double-entry accounting, we’ve come up with this single-entry accounting example. For a business that utilizes a single-entry system, the accounts may look like this:
- Starting balance at the beginning of the accounting period: $30,000
- Bank loan payment received: $5,000, new balance = $35,000
- Rent paid $2,000, closing balance = $33,000
On the surface, it seems as though the business has increased its balance by $3,000 during the accounting period, but with a single-entry system, there is information missing. The company may have liabilities, which are not included, and the books don’t tell you where you’ve taken the $2,000 for your rent from.
Double-Entry Accounting Example
Now, let’s look at a double-entry accounting example.
You want to buy a new computer at a cost of $1,000 for your business. In the double-entry system, you would record a debit on your Expenses account and a credit on your Cash account. This means that the sum, $1,000, has a clear origin and destination.
Understanding Credits and Debits
Understanding credits and debits is crucial to master the basics of double entry. Every business transaction causes a credit in one account and a debit in another.
If you receive money from the bank in the form of a loan, for example, this will increase your asset balance, but at the same time, it’ll also increase your liabilities by the same value. A transaction that causes your assets to rise will cause another account to fall.
Credits will increase your revenues, liabilities, and equities accounts.
Debits will increase your assets and expenses accounts.
When you use a double-entry bookkeeping system, debits are recorded on the left-hand side of the page, and credits are recorded on the right-hand side.
Double-entry accounting helps businesses to satisfy the recognized accounting equation:
Assets = Liabilities + Equity
Benefits of a Double-Entry System of Accounting
Using a double-entry system of accounting offers benefits for a wide range of businesses. The primary advantages of a double-entry system over single-entry accounting include:
Keeping accurate books is critical to success in business. Double-entry systems are more accurate because they flag up data entry mistakes. Correcting and identifying errors at the earliest possible stage reduces the risk of making plans or decisions based on inaccurate or incomplete data.
Double entries provide a complete record of transactions, giving you an accurate and helpful overview of the company’s financial situation.
Recording Assets and Liabilities
Basic accounting methods will give business owners an idea of profits and losses, but they don’t track assets and liabilities via single transactions.
With double-entry accounting, business owners and company directors can see both their assets and liabilities, which provides a more clear picture of the company’s finances.
Making Well-Informed Decisions
Financial planning is essential for businesses operating across all sectors. From small businesses trying to stay afloat to large companies looking to expand and grow, it’s vital to have access to accurate accounts and income and balance sheets to make well-informed decisions.
Business owners need to be able to check if they can afford to invest money, make purchases, hire extra staff, or borrow money, for example.
If the accounts lack detail or only contain information about assets, there is a risk of getting into financial trouble.
Double-Entry Accounting Software
Double-entry accounting may seem more complex and time-consuming than single-entry accounting, but there are ways to simplify it and save time while reaping the rewards of a more detailed and accurate accounting system.
Double-entry accounting software makes utilizing double-entry accounting quick and easy. In most cases, when you use such software, you just need to enter information about the transaction, and the software will already be looking for the second part.
In addition to using double-entry accounting software to balance your books, you can also take advantage of the opportunity to create additional reports for your business, including balance and income sheets and a trial balance.
The trial balance lists all of the accounts with recorded activity and labels accounts that have regular debit and credit balances. The trial balance should be zero, as the total value of credits should equal the total number of debits.
What is the rule of double entry?
Double entry accounting is a concept based on recording transactions in at least two accounts. This means that a transaction is debited from one account and credited to another. By using double-entry systems, you should be able to ensure that your accounts are balanced. Double-entry accounting satisfies the accounting equation: Assets = Liabilities + Equity.
Who introduced double-entry?
The concept of the double-entry system is credited to a Franciscan friar known as Luca Pacioli, who lived in 15th-century Italy. Double-entry accounting became increasingly popular in Europe and has long been recognized as a standard accounting method.
What are the advantages of double-entry?
Double-entry accounting is a more accurate and detailed methodology, which provides business owners with a precise, verifiable overview of their company finances. Double entry is more robust and complex than single entry, it provides more information, and it helps to lower the risk of financial mistakes. Business owners can utilize accurate accounts and reports to make decisions and take the guesswork out of making financial plans. Unlike single-entry accounting, double entries cover liabilities and assets.
Albert Einstein is said to have identified compound interest as mankind’s greatest invention. That story’s probably apocryphal, but it conveys a deep truth about the power of fiscal policy to change the world along with our daily lives. Civilization became possible only when Sumerians of the Bronze Age invented money. Today, economic issues influence every aspect of daily life. My job at Fortunly is an opportunity to analyze government policies and banking practices, sharing the results of my research in articles that can help you make better, smarter decisions for yourself and your family.
More from blog
Your email address will not be published.