Double Entry: What It Means in Accounting and How Its Used

As a company’s business grows, the likelihood of clerical errors increases. Although double-entry accounting does not prevent errors entirely, it limits the effect any errors have on the overall accounts. With single entries, fraudulent activities become common, and tampering with the record is usual for companies. On the other hand, it’s easy to track accounting errors and issues in a double-entry bookkeeping system when the credit and debit sides don’t tally. The first case denotes a debit record and a corresponding credit, indicating a net effect, which comes to zero.

Types of Business Accounts

It requires a solid understanding of the basic principles, the relationship between debits and credits, and how they affect different accounts. Manually managing double-entry bookkeeping can also be time-consuming and prone to errors, especially for businesses with high transaction volumes. However, with the help of accounting software, the process becomes significantly easier and more efficient. The likelihood of administrative errors increases when a company expands, and its business transactions become increasingly complex. While double-entry bookkeeping does not eliminate all errors, it is effective in limiting errors on balance sheets and other financial statements because it requires debits and credits to balance. In order to achieve the balance mentioned previously, accountants use the concept of debits and credits to record transactions for each account on the company’s balance sheet.

1. The purchase of furniture on credit for $2,500 from Fine Furniture is recorded on the debit side of the account (because furniture is an asset and is increasing).
2. Also, a corresponding entry of $2,500 is made on the credit side of the account because the liability to this creditor is increasing.
3. By posting journal entries to the general ledger, accountants can track the impact of each transaction on the individual accounts, and ultimately, on the company’s financial position.
4. The double-entry system of accounting or bookkeeping means that for every business transaction, amounts must be recorded in a minimum of two accounts.
5. The financial position of the business on a certain date is evaluated or determined by listing assets and liabilities in a balance sheet.
6. If the transactions are recorded correctly, the profit and loss account and balance sheet will provide accurate and complete results.

The Basic Accounting Equation

Assets (the inventory account) increase by $1,000 and liabilities (accounts payable) increase by $1,000. Now that we understand the basics and features of double entry accounting, let us apply the knowledge to practical application through the examples below. The debit and credit sides of a ledger should always be equal in double-entry accounting. As you can see, the entire accounting process starts with double-entry bookkeeping. Whether you do your own bookkeeping with small business bookkeeping software or hire a bookkeeper, understanding this critical accounting concept is essential for the success of your small business. Bookkeeping supports every other accounting process, including the production of financial statements and the generation of management reports for company decision-making.

For both entities, total equity, defined as assets minus liabilities, has not changed. Double-entry bookkeeping, also known as double-entry accounting, is a method of bookkeeping that relies on a two-sided accounting entry to maintain financial information. Every entry to an account requires a corresponding and opposite entry to a different account.

It also helped merchants and bankers understand their costs and profits. Some thinkers have argued that double-entry accounting was a key calculative technology responsible for the birth of capitalism. Any reputable, modern accounting software (like FreshBooks) is double-entry by default, which makes it easy to switch to double-entry bookkeeping for your business. For example, if you sell a product on credit, your receivables increase, and your inventory decreases.

Double-entry bookkeeping means that a debit entry in one account must be equal to a credit entry in another account to keep the equation balanced. In summary, the accounting cycle is a systematic process for recording, summarizing, and reporting business transactions using double-entry accounting. This method allows for enhanced accuracy, prevention of fraud, and a clear picture of a company’s financial health. The key components covered in this section included recording transactions, posting them to the general ledger, and preparing the trial balance. The third subsection in the accounting cycle involves preparing the trial balance. A trial balance is a report that lists all the balances of the general ledger accounts, ensuring that the total debits equal the total credits.

The Accounting Cycle

Under the double-entry system, the ledger contains a number of accounts, perhaps just a few or perhaps double entry system means many thousands. For example, consider receiving a check for $5,000 as a vehicle insurance provider. To account for this transaction, $5,000 is entered into the insurance account as a debit. This account will eventually be a charge in the profit and loss account.

That’s a win because financial statements can help you make better decisions about what to spend money on in the future. Before pacioli’s contribution, some form of double entry system of accounting was already in practice. However, it was pacioli’s book that introduced the system in Europe and other trading countries of the world. As the acknowledgement of his work, Pacioli is known as the “father of accounting” by modern accounting professionals.

If you don’t use double-entry accounting, your receivables will increase but you’ll be overstating your inventory. At year-end, it will look like you’d have more inventory on your books than you actually have on hand. When you collect the money of $5,550, your cash increases (debit), and your receivables decrease (credit) by $5,550. But first, to understand how the double-entry system works, you need to understand the basic accounting equation. Say you purchased $1,000 of supplies for your business every month for a year. You recorded the money coming out of your checking account but didn’t record the supplies expense totaling $12,000.

Even if you don’t have an accountant or bookkeeper now, you may at some point. You’ll be ahead of the game if you’re already using double-entry bookkeeping. Plus, more accurate data means they can give you better advice on tax deductions and the financial health of your business.