A Beginner’s Guide to Double-Entry Accounting

Posted by: peter Category: Bookkeeping Comments: 0

A Beginner’s Guide to Double-Entry Accounting

Many companies, regardless of their size or industry, use double-entry accounting for their bookkeeping needs because it provides a more accurate depiction of their financial health. This bookkeeping method also complies with the US generally accepted accounting principles (GAAP), the official practice and rules for double-entry accounting. When you generate a balance sheet in double-entry bookkeeping, your liabilities and equity (net worth or “capital”) must equal assets. Essentially, the representation equates all uses of capital (assets) to all sources of capital (where debt capital leads to liabilities and equity capital leads to shareholders’ equity).

  • Here is a simplified look at how debits and credits work under the double-entry bookkeeping system.
  • For instance, if a business takes a loan from a financial entity like a bank, the borrowed money will raise the company’s assets and the loan liability will also rise by an equivalent amount.
  • A bachelor’s degree in accounting can provide you with the necessary skills to start an entry-level role as an accountant.
  • The general ledger, which tracks debit and credit accounts, must always be balanced.
  • Because the double-entry system is more complete and transparent, anyone considering giving your business money will be a lot more likely to do so if you use this system.

The accounting equation forms the foundation of double-entry accounting and is a concise representation of a concept that expands into the complex, expanded, and multi-item display of the balance sheet. The balance sheet is based on the double-entry accounting system where the total assets of a company are equal to the total liabilities and shareholder equity. It allows a business to track all its transactions and helps it to understand how it is performing in terms of profitability, cash balances and business growth. It also supports all the ongoing reporting and submission requirements businesses have – VAT returns, annual accounts, tax returns, etc all rely on double-entry bookkeeping. Double-entry bookkeeping is a system of accounting for financial transactions that has been used for hundreds of years.

Examples of Double-Entry Bookkeeping

When you pay for the domain, your advertising expense increases by $20, and your cash decreases by $20. When you receive the money, your cash increases by $9,500, and your loan liability increases by $9,500. Double-entry bookkeeping was developed in the mercantile period of Europe to help rationalize commercial transactions and make trade more efficient. 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.

  • Using double-entry bookkeeping to record transactions provides you and your accountant with a detailed, comprehensive view of your financial affairs.
  • If you were using single-entry accounting, you would simply reduce your bank account balance by $500.
  • The general ledger would have two lines added to it, showing both the debit and credit for $5,000 each.

Once that is set up, the chart of accounts is used as a point of reference each time two or more accounts are selected in order to enter a transaction into the general ledger. Along the way, more accounts may be added to the chart of accounts while others may be deleted if you realize they will never be used. Let’s look at the equation in the context of the aforementioned print ad example.

You can also connect your business bank account to make recording transactions easier. The chart of accounts is a different category group for the financial transactions in your business and is used to generate financial statements. There are two different ways to record the effects of debits and credits on accounts in the double-entry system of bookkeeping. Irrespective of the approach used, the effect on the books of accounts remains the same, with two aspects (debit and credit) in each of the transactions. An example of double-entry accounting would be if a business took out a $10,000 loan and the loan was recorded in both the debit account and the credit account.

How to get started with double-entry accounting

When setting up financial records for a business, it’s important to create a detailed listing known as a chart of accounts. Typically, accounting software provides suggestions on the typical type of accounts that a business may require. The basic rule of double-entry bookkeeping is that each transaction has to be recorded in two accounts (credits and debits).

Why Is Double-Entry Bookkeeping Important?

The total amount credited has to equal the total amount debited, and vice versa. When entering business transactions into books, accountants need to ensure they link and source the entry. In double-entry bookkeeping, debits and credits are terms used to describe the 2 sides of every transaction. Debits are increases to an account, and credits are decreases to an account.

Module 4: Financial Statements of Business Organizations

Unlike single-entry accounting, which requires only that you post a transaction into a ledger, double-entry tracks both sides (debit and credit) of each transaction you enter. If you’re not sure whether your accounting system is double-entry, a good rule of thumb is to look for a balance sheet. If you can produce a balance sheet from your accounting software without having to input anything other than the date for the report, you are using a double-entry accounting system. Now, you can look back and see that the bank loan created $20,000 in liabilities. Liabilities and equity affect assets and vice versa, so as one side of the equation changes, the other side does, too.

Thanks to accounting software, this is done automatically as you enter amounts and designate which account it is connected to. Even better is the fact that accounting software can automatically generate these entries when a sales invoice or a check is prepared. Using software to help manage common tasks like invoicing and expense tracking improves accuracy while also saving time. If Lucie opens a new drop shipping sales tax grocery store, she may start the business by contributing some of her own savings of $100,000 to the company. The first entry to the general ledger would be a debit to Cash, increasing the assets of the company, and a credit to Equity, increasing Lucie’s ownership stake in the company. Double-entry bookkeeping is the concept that every accounting transaction impacts a company’s finances in two ways.

Using double-entry accounting to ensure accurate record-keeping

When using the double entry accounting system, two things must always be balanced. The general ledger, which tracks debit and credit entries, must always be balanced. Additionally, the balance sheet, where assets minus liabilities equals equity, must also be balanced. Although single entry bookkeeping is simpler, it’s not as reliable as double entry bookkeeping and isn’t a suitable accounting method for medium to large businesses. A bookkeeper reviews source documents for instance receipts, invoices, and bank statements—and uses those documents to post accounting transactions within a proper accounting software solution.

This complexity can be time-consuming as well as more costly; however, in the long run, it is more beneficial to a company than single-entry accounting. Every transaction involves two fold aspects e.g., an aspect of receiving and an aspect of giving. Under the double entry system, both the aspects of giving and receiving are recorded in terms of accounts.

A journal entry refers to the record you’ll make in your general ledger (GL) for every financial transaction. Some accounting software, like Xero and QuickBooks Online, automatically generate journal entries for your GL each time you accept a payment or pay a bill. Other software, such as Zoho Books’ free plan, requires you to make manual journal entries. If your credit entries don’t match your debit entries, you’ll likely need to identify the accounting error and then make an adjusting entry to bring your books back into balance. Double-entry accounting is a bookkeeping system that requires two entries — one debit and one credit — for every transaction. Unlike single-entry accounting, which focuses on tracking revenue and expenses, double-entry accounting also tracks assets, liabilities and equity.