While single-entry accounting is quick and easy to use, the standard method for recording transactions is double-entry. Double-entry accounting is a bookkeeping method that allows you to track where your money comes from and where it’s going.
In this article, we’ll explain, as simply as we can, everything you need to know when you start setting up your bookkeeping.
What is double-entry accounting?
Double-entry accounting or double-entry bookkeeping is based upon the fact that every transaction has two parts and that this will therefore affect two ledger accounts.
Every transaction involves a debit entry in one account and a credit entry in another account. This means that every transaction must be recorded in two accounts; one account will be debited because it receives value and the other account will be credited because it has given value. For example, if your company purchases goods, your inventory account goes up while your cash goes down.
The rule to remember is "debit the receiver and credit the giver".
The debit and credit rules in double-entry bookkeeping
When making journal entries in your general ledger, debit is an entry on the left side of an account and credit is an entry on the right side of an account.
The T Account
The T Account is used to analyze the transactions.
Debit is commonly abbreviated Dr.
Credit is commonly abbreviated Cr.
Footings, the total of each side are computed.
The difference between the debit side and the credit side is the account balance, either debit or credit.
Credits increase revenue, liabilities, and equity accounts, whereas debits increase assets and expense accounts. Debits must be equal credits.
For each transaction, the total of the debit amounts must be the same as the total of credit amounts
What is the accounting equation?
As to mention, every debit always has an equal corresponding credit, which is based on the following equation in balance:
The famous Accounting equation:
Assets = Liabilities + Equity
Account Type | Debit | Credit |
Assets | ↑ | ↓ |
Expenses | ↑ | ↓ |
Revenue | ↓ | ↑ |
Liabilities | ↓ | ↑ |
Equity | ↓ | ↑ |
Application of Debit/Credit Rules to Stockholder’s Equity
Assets = Liabilities + Common Stock + Retained Earnings – Dividends + Revenues – Expenses
The accounting equation can be rearranged to shift dividends and expenses to the left side.
Assets + Dividends + Expenses = Liabilities + Common Stock + Retained Earnings + Revenues
This equation is one of the fundamental principles of accounting, in which total assets must always equal total liabilities plus equity (net worth or capital) of a business. In case both sides of the calculation are out of balance, that means the bookkeepers or accounts have made a mistake somewhere along the way.
Double-entry accounting sample
Let’s take an example: you receive a bank loan of $20,000. In this example, both sides of the equitation are affected - assets and liabilities. Your Assets (Cash) increase by $20,00 because you have more cash to spend in the present. Meanwhile, your Liabilities (Received bank loan) increase by $20,000 because you’’ need to pay your lender back in the future. Then, the equation remains balanced.
Account | Debit | Credit |
Cash | $20,000 | |
Liabilities | | $20,000 |
Why Is Double-Entry Bookkeeping Important?
The double-entry accounting system has been used for hundreds of years, and now with the support of technology, it has become a powerful method that delivers many advantages.
This method is an effective way to monitor the financial health of a company, allowing you to generate a variety of crucial financial reports like a balance sheet and income statement that help you make better financial decisions in the future.
Although double-entry accounting does not prevent errors entirely, it limits the effect any errors have on the overall accounts.
Additionally, the nature of the account structure makes it easier to trace back through entries to find out whether an error originated.
Double-entry accounting software
Most modern accounting software, such as Quickbooks Online, Xero, and FreshBooks, is based on the double-entry accounting system that makes it easier for bookkeepers to keep track of transactions. Accounting software also helps you generate reports to prepare year-end and tax records.
Although accounting software provides a simple solution with double-entry accounting for business owners, the users need to have basic accounting knowledge to use it properly. It will take time and effort, so it’s better to hire a bookkeeper to do this work for you.
Irvine Bookkeeping Services is powered by dedicated humans, powerful accounting software, and a solid skill set that will give you experienced bookkeepers supported by a team of knowledgeable small business experts. We’re here to take the guesswork out of running your business - for good. Get started with a Free Initial Consultation.
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