Double-entry accounting can help you enhance the financial record-keeping of a business. In today’s article, we will help you learn about the basics of double-entry bookkeeping along with its relevant examples.
Several companies, irrespective of the industry or size, access double-entry accounting to meet their bookkeeping requirements, since it offers a more precise representation of their financial status. The double-entry bookkeeping procedure also follows the US generally accepted accounting principles like (GAAP), which is the formal practice and rules for double-entry accounting.
In today’s article, we will talk about double-entry accounting, how it operates, and how it benefits the business.
What is a Double Entry System of Accounting?
The double-entry system is a type of process of accounting that registers financial transactions in two accounts, in order to balance the accounting equation:
Assets = Equity + Liability
Transactions are registered in credits and debits, and both have an equal and opposite reaction. It is precise in terms of mathematics and is considered one of the most widely used accounting systems.
Before we move further, we need to be aware of the ground rule of double-entry bookkeeping.
What are the 3 Major Components of the Double-Entry Bookkeeping System?
Here are the three major components of the double-entry bookkeeping system:
- For every transaction, the total credits recorded should be the same as the total debits recorded
- Every accounting entry or business transaction needs to be registered in a minimum of two accounts in the particular books
- Total assets and total liabilities should always be equal along with the equity (capital or net worth) of a business. Ensure both sides of this equation do not differ
Who implements the Double-entry Bookkeeping System?
For businesses in the United States, the Financial Accounting Standards (FASB) is a non-government body. They finalize on the Generally Accepted Accounting Principles (GAAP), which are considered as the official rule and procedure for double-entry bookkeeping.
Public companies may use the double-entry bookkeeping system and implement any methods or rules prescribed by International Financial Reporting Standards or GAAP.
Small business enterprises that have more than one employee or wish to apply for a loan must use double-entry bookkeeping. This system is more precise and is considered a complete way to monitor the financial health of a company and how rapidly it is expanding.
Now let us learn about the single-entry system of accounting.
What is the Single-Entry System of Accounting?
The double-entry system registers every transaction more than once, while the single-entry system of accounting records every transaction only once.
The single-entry system is a basic process of bookkeeping that registers only one side of any transaction, usually the bank account or cash account, and does not take into consideration the parallel entry for the other account.
It does not offer a proper picture of the financial transactions and is only accessed by individuals or small businesses who have restricted accounting requirements. It does not provide the complete picture of the financial performance of the business and is not assumed to be mathematically precise.
For this particular reason, nearly all accountants and businesses like the double-entry system of accounting.
To understand it better, let us learn about the basic differences between single-entry and double-entry systems.
What are the differences between Single Entry and Double Entry System?
Here are some of the instances of a double-entry accounting system and single-entry accounting system:
- A company registered a sale of goods by crediting the sales revenue account and debiting the accounts receivable account
- A company that registers the buying of inventory by crediting the accounts payable account and debiting the inventory account
- A freelancer registers all the expenses and income in a spreadsheet
- A small business owner registers all-cash sales in a particular cash register
Here is a table that explains in detail the key differences between Single-entry accounting and Double-entry accounting:
|Does not offer a comprehensive picture of the financial health of a business.
|Offers a more complete and precise picture of the financial plan of a business.
|Simple and direct system.
|It is a far more complicated system, but offers more details.
|Every transaction is recorded not more than once.
|Every transaction is recorded two times, one time as a debit and the other one as a credit.
|More vulnerable to problems, since there is no built-in tool to check the accuracy.
|It is not vulnerable to errors, this is because credits and debits must always be the same
|Fit for small businesses that has low volume of transactions.
|Ideal for all businesses, irrespective of volume or size of transactions.
What are the Different Kinds of Business Accounts?
Accounting and bookkeeping are used to record, measure, and communicate the financial information of a firm. A business transaction is like an economic event that is registered for bookkeeping or accounting purposes.
In simple terms, it is a business communication between economic entities like businesses, customers, or businesses and vendors.
- Assets: Any value which is owned by the company like goodwill or machinery
- Liabilities: Any value which is owed by the company like accounts payable or loans
- Equities: Value of the shared generated
- Revenue: Value that the company earned by selling goods or services
- Expenses: Value spent in operations by the company
- Gains: Non-revenue incomes such as interest income
- Losses: Non-revenue expenses like loan payments
Debits and Credits
Credits and debits are necessary for the double-entry system to function. An entry on the left side of an account ledger is referred to as a debit in accounting, and an entry on the right side is referred to as a credit. For a transaction to be considered in balance, the sum of its debits and credits must match. It’s not always the case that credits equal declines and debits equal rises.
One account may be debited while another is credited. The standard accounting equation, Assets = Liabilities + Equity, is supported, for instance, when a debit boosts asset accounts while decreasing liability and equity accounts. Debits raise the amounts in the expense and loss accounts on the income statement, whereas credits lower those levels. The balances of income accounts are increased by credits and decreased by debits.
How to Record Entries in Bookkeeping?
In the single-entry system, entries are registered in a cash register or a cash book, mainly focusing on cash or bank transactions.
Cash inflows such as revenue are registered as receipts. However, cash outflows such as expenses are registered as payments. Non-cash transactions such as depreciation on assets are generally not registered, and that is why it is a partial record of accounts.
In the double-entry system, entries are registered in the following system:
- Ledger: From the journal, information is sent to ledger accounts, where all transactions are categorized into their concerned accounts and then the final account balance is determined.
- Trial Balance: The account balances are determined in the ledger, and are sent to the trial balance where the final credit and debit balances are determined. Make sure the two balances are equal always. In this way, the trial balance ensures mathematical precision.
- Journal: A transaction’s first entry is made in the Journal, where details regarding the amounts debited or credited as well as a small description of the transaction are stated.
- Financial Statements: From the trial balance, information is shifted to the three main financial statements Balance Sheet, Income Statement, and Cash Flow Statement.
What are the Advantages of the Double-Entry system?
The double-entry system is generally used and widely accepted as a process to record financial transactions, acknowledged universally across all the domains.
- Steady and Global: Double entry system of accounting follows extremely precise guidelines and formats. This guarantees that all businesses’ books of accounts are the same. As long as the company uses the double-entry accounting method, anyone familiar with this format should be able to read its books of accounts.
- Precise and Scientific: It is certain that double entry system books of accounts are accurate and scientific since the system precisely documents both sides of the transaction.
- Financial Analysis scope: Every transaction a business engages in is comprehensively and chronologically recorded by the double-entry accounting system. This provides a good deal of room for creating complicated charts showing the expansion of the company. Analysts utilize accounting ratios that are exclusive to double-entry books of accounts.
What are the instances of the Double-Entry Accounting system?
Assume that a store sells a product for Rs. 500 in cash. This particular transaction will comprise two accounts- Sales Revenue and Cash Account.
- Debit: Rs. 100
- This shows a rise in the Cash account since the store gets Rs.100 in cash from the particular sale.
Sales Revenue Account:
- Credit: Rs. 100
- This shows a rise in the Sales Revenue account since the store earns Rs. 100 in revenue from the particular sale.
The double-entry system makes sure that each transaction has a minimum of two entries, one debit and one credit which keeps the accounting equation balanced.
The books are in balance in this instance because the total debit (Rs. 100) and total credit (Rs. 100) are equal. This technique makes it possible for firms to effectively track their financial health and helps track accurate financial records.
We hope that after reading this article, you have an idea about what double-entry bookkeeping is all about. In this article, we have shared everything relevant to double-entry bookkeeping. Still, if you have any doubts, you can get in touch with our team of experts.
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