What is Double-Entry Bookkeeping
Double entry is a fundamental concept related to modern bookkeeping and accounting. Double-entry accounting is a system that states that any financial transaction within a business has equal and opposite effects in two different accounts. Therefore, such a transaction needs two book entries —debit and credit. The books are said to be balanced when the sum of each of the debits and its corresponding credit becomes zero. The method of single-entry accounting takes only revenue and expenses into account. However, the double-entry accounting method considers equity, assets and liabilities as well. In this method, transactions are recorded as debits and credits. A debit in one account offsets the corresponding credit in another. Hence, the total of all debits must be equal to the sum of the credits. From the name, it may seem to you that this process involves double the regular work. But, it gives a more detailed assessment of how money is flowing through the layers of your business. Moreover, the double-entry system standardizes the process of accounting and boosts the accuracy of financial statements. Thus, it protects the business against costly accounting errors.
Single-Entry vs. Double-Entry Accounting
The following table will give you a comparative idea of the single entry and double-entry accounting-
A transaction has only one entry.
Every transaction has two entries for it
Prone to accounting errors
Reduces accounting mistakes/errors.
Much easier. can be maintained in a spreadsheet or as handwritten
Should be used with accounting software.
Can’t provide much insight beyond a profit and loss statement.
It can provide important insight into the overall financial health of a business.
Freelancers, service-based businesses and sole proprietors with fewer assets, liabilities or inventory.
All small businesses with considerable inventory, assets or liabilities.
Tracks only revenue and expenses
Tracks assets, liabilities and equity, in addition to revenue and expenses.
Example of Single-Entry Accounting
Single-entry accounting is similar to maintaining our accounts on a cash book. Here, entries usually include an amount, date, remaining balance and description. Here is an example to make it easier for you-
Let us assume you started the month of October 2020 with $50,000 in your business account. Also, you paid rent and received a loan from the bank this month. Now, in Single-entry accounting, your entries may look like this:
Received loan from the bank
Paid monthly rent
From the above, you will get to know that your business is having a surplus of $17,000 from where it started at the beginning of the month. But this doesn’t quite reflect the health of your business. Please note that your business has $20,000 in liabilities. This needs to be paid back to the bank, along with the applicable interest. These entries will not give you an idea as to which account the rent amount was withdrawn from. Now you understand why single-entry accounting is not sufficient for growing businesses.
Example of Double-Entry Accounting
Let us go back to our example in the previous section. We will describe the same scenario with the help of the double-entry system now. Your entries will now look like this:
Received loan from the bank
Paid monthly rent
Now, from the above entries, you can see that the bank loan added $20,000 to your liabilities. It is also evident that the money for rent was withdrawn from your cash account. Thus, the double-entry system depicts a clear flow of money through your business layers, with a proper mentioning of the source and destination.
What are Debit and Credit?
Every transaction made in the normal course of your business gives rise to a debit in one account and a credit in another. In accounting, a debit indicates an entry on the left side of the ledger and a credit indicates an entry on the right side. Together, debit and credit represent the flow of money into and out of the business. The value of one account increases with a corresponding decrease in another. For example, if a transaction increases your assets, it will be shown as a debit to the corresponding assets account. On the other hand, the transaction would also be shown as a credit in another account. The sum of debit and its corresponding credit must be zero. Credits add to the revenue, equity and liabilities accounts and debits add to expense and asset accounts.
What is the basic accounting Equation in Double-Entry Accounting?
The following equation forms the very basis of double-entry accounting:
Assets = Liabilities + Equity.
Equity and Liabilities affect assets and vice versa. Any change in one side of the equation changes the other side as well. This explains the reason why one business transaction affects two accounts and needs two entries. In our example above, you saw that when you avail of a business loan, there is an increase (credit) in your liabilities account as you will have to pay your lender the principal amount in the future, along with the interest amount. On the other hand, your cash assets have a corresponding increase (debit) as you have more cash now for your business expenditure. The same becomes true if you invest your personal money into your startup business. Your business assets increase (are debited) as you have more cash now for your business. At the same time, as an owner, your equity increases (credited), as you have become a shareholder now.
Double-Entry Accounting Software
The majority of the modern accounting software such as Sage, QuickBooks Online, Xero etc are based on the double-entry accounting system. When you enter a business transaction into such software, the other part of the transaction is populated automatically by the software. If you are not sure if your accounting software is using double-entry, you can have a look at a balance sheet. If your software can produce a balance sheet without you having to input anything apart from the report date, your software is based on the double-entry accounting system.
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