Ever wonder what double entry bookkeeping is all about? Then this is your guide.
Why Double-Entry Bookkeeping Is The International Standard Among Bookkeepers
Simply put, double-entry bookkeeping encourages greater accuracy in a business’s record-keeping system. Using a double-entry system means businesses get an accurate depiction of their financial condition.
Historians believe double-entry bookkeeping was established in Italy during the mercantile era. The system was used to enhance trade efficiency and explain how trading works. The double-entry system assisted the period’s bankers and traders to understand why costing was so important. They began to grasp how profits and losses worked.
It’s possible that the technology surrounding double-entry accounting contributed to the advent of capitalism.
All public companies have to use the double-entry accounting system. This is in keeping with the rules, methods, and guidelines set by the IFRS. Hence, double-entry bookkeeping is the accepted standard for bookkeepers and accountants worldwide.
What Is Double-Entry Bookkeeping?
Double-entry accounting is a bookkeeping system that records financial transactions in two different accounts of a set of books. For every debit entry in a ledger, there has to be a credit entry entered for the same amount in another account.
By doing this, each transaction gets checked against the corresponding entry. This provides greater accuracy and lessens the chance of fraud. Double-entry bookkeeping also provides a more effective way of tracking finances. Hence, you’re able to make more informed resource allocation calls for your business.
When a bookkeeper enters a financial transaction into a set of books, they also link the entry to the original document. This justifies the transaction. Thereby, a means to track and prove the validity of the transaction during an audit, for example, are provided.
The double-entry bookkeeping system of capturing transactions supports other accounting processes. These include the generating of financial statements and management reports.
Double-Entry Bookkeeping Basics
The fundamental rule of the double-entry bookkeeping system is that you should always enter every transaction twice. There must always be a debit and a credit.
Because a debit entry in one account is offset by a credit entry in the other, these amounts should balance out. The total of all debits and credits in the respective columns should be the same.
What Are Debit And Credit Entries?
In financial terms, a debit and credit entry are complete opposites. A debit indicates an increase to an asset account and always appears in the left column of a ledger. A credit entry, in contrast, increases a liability and equity account while decreasing an asset account balance. A credit will always appear on the right-hand column of a ledger.
One fact to bear in mind is that debits don’t always mean an amount is increasing. Likewise, credits aren’t always decreasing amounts. In an income statement, loss and expense account balances get increased through debit entries. Liability, equity, and income accounts will experience decreases. Credits do the opposite in these accounts.
Let’s sum up debits and credits:
- Always entered in the left column of a ledger
- Increase asset and expense accounts
- Decrease equity, income, and a liability account
- Always appear in the right ledger column
- Increase income, equity, and a liability account
- Decrease expense and asset accounts
Types of Accounts in Double-Entry Accounting
Double-entry accounting and booking systems capture, record, and reflect the financial transactions of a business. Every financial transaction made within a double-entry system is part of a business relationship. These relations exist between the business and its banking institution, tax office, customers, or suppliers.
A double-entry accounting system is structured to make tracking these transactions easier and more efficient. The recognised process is standard according to generally accepted accounting principles. All transactions are captured within five primary types of accounts for easy classification. These accounts are as follows:
- Income accounts: These include all the business revenue accounts for income received from sales and interest.
- Expense accounts: Expenses represent business costs, including security charges, rentals, utilities, and repairs.
- Asset accounts: These accounts show a business’s resources like its inventory, equipment, and its cash.
- Liability accounts: A business’s liabilities are its debts. These include payable accounts and outstanding loans.
- Equity accounts: These represent the retained income of a business – its profits less operational outlay. Investment injected into the business is also equity.
With double-entry accounting, bookkeepers and accountants can easily monitor and manage these accounts. This simplifies the process as further business transactions get added.
Double-Entry Bookkeeping Advantages
Using a double-entry bookkeeping system affords several advantages to a business. Some of the notable ones are:
- A double-entry system gives owners and stakeholders a more transparent idea of the financial health of the business. Informed decision-making becomes easier through the system’s ability to generate a trial balance, balance sheet, and other financial statements.
- Double-entry bookkeeping pinpoints areas of the business that aren’t operating optimally. It can also highlight those that are profitable.
- A double-entry system makes fraud attempts and data capture errors more obvious to identify.
- A double-entry system using the standard accounting equation makes it capable of providing investors or banks with a clear view of the business’s financial status. This improves the chances of further investment or securing loans.
The above benefits are only a few that double-entry accounting and bookkeeping systems hold. The ease of use of modern double-entry accounting programs now makes the bookkeeping function easier and more accurate.
Double-Entry Accounting Software Programs
As technology progresses, the double-entry accounting software available to businesses has also advanced. Accounting software is able to automatically reconcile information from different account types. The accounting equation and function are also more automated.
Some of the more popular double-entry accounting software on the market assists with financial transaction tracking. Quickbooks and Xero have a general ledger, trial balance, and receivable and payable accounts included. These double-entry software packages remove pressure from their operators.
These software programs automatically inspect every business transaction inputted. They can generate a trial balance easily to ensure the double entry method is in balance. Profits and losses get automatically calculated and businesses can generate financial statements or a balance sheet for any period of their choosing.
Double-entry bookkeeping and accounting software programs are testimony to the effectiveness of the double-entry system. Businesses operating on a single-entry bookkeeping system should consider the viability of changing.
How Does Single-Entry Bookkeeping Work?
We have already explained how double-entry bookkeeping works, so let’s focus on single-entry bookkeeping and how it differs.
Single-entry bookkeeping is a very basic form of keeping books, with every transaction only captured once. The system can be completed by hand, or on a computer spreadsheet. One-person or small businesses completing only a few transactions can benefit from this fundamental accounting.
Double-entry bookkeeping tracks both sides of every transaction, but single-entry systems only have one entry per transaction. This gets entered into a single column.
The single-entry system shows accounts payable and accounts receivable directly under each other. These are only differentiated from each other via a negative or positive indicator. In other words, incoming amounts get shown as positives, while expenses going out are shown as minus amounts.
For this reason, single-entry systems never truly show the full financial process.
In the long run, the business owner will know whether the enterprise is making or losing money due to its credit balance or debit balance. Should an invoice or receipt be missed in processing, however, there is no way to double-check. These kinds of inaccuracies could have serious implications for tax return amounts, for example.
We’ve provided much insight into what double-entry bookkeeping is and why it makes sense for all businesses to utilise the system. If you’re not capable of doing so yourself, it makes sense to outsource to an accounting firm that can do the hard work for you. With at least two accounts used for each accounting entry, you can be confident your finances will be better off.
What is a trial balance in double-entry bookkeeping?
A trial balance lists all the account balances in a business’s general ledger. It gives a summary of the debit and credit balances for each account to show the total debit and total credit balance. If they don’t, you can easily identify the errors prior to financial statement preparation.
Can errors occur in double-entry bookkeeping?
Yes. Common errors that can happen include inputting transactions incorrectly or leaving them out altogether. You could post entries to the wrong accounts, or not balance debits and credits. Frequent reconciling can identify and correct these errors.