Why is double-entry bookkeeping such a big deal?
Accounting is the process of recording, classifying, and summarizing financial transactions to provide information that is useful in making business decisions.
There are several different accounting methods, but the most commonly used approach is double entry accounting. In this system, every financial transaction is recorded twice, once as a debit and once as a credit.
This helps ensure accuracy and provides a more complete picture of a company's financial health. Finance students should learn how to use double entry accounting in order to understand financial statements and make sound investment decisions.
Entries into the general ledger use double-entry bookkeeping, so in this lesson you will learn about this underlying system for accounting processes.
Double entry is also known as dual effect or dual aspect, because every transaction has two impacts on a business. For example, if Company A buys a delivery vehicle for cash, then cash reduces and the new asset (the vehicle) is introduced to the business. You will see this concept being applied to all the transactions posted into the general ledger.
What is double entry accounting?
Double-entry bookkeeping is a fundamental process that all accountants need to use, so mastering this is an important stage in your learning. Once you have understood the principles of this process and done some practice, you will have made significant progress in your studies.
As the name suggests, double entry means that for every accounting transaction there will be two impacts. We call one of these a debit and the other a credit.
If a business purchases a motor vehicle to use in the business, then it will increase the business's assets. If this is paid for with cash, this will reduce the business's bank balance. The double entry for this will be:
- Debit: Asset
- Credit: Bank
Double entry bookkeeping is when your account's being debited, another account must be being credited, so it's a balance. The basic principle of double entry bookkeeping is for every credit entry there's always a debit entry, and for every debit entry there's always a credit entry. Basically, there's always a matching entry for the credit entry, and there's always a matching entry for the debit entry. As long as the entries are posted correctly, then the account will balance.
Now we understand the principles of double entry, we know that to post a transaction there are two impacts, a debit and a credit. The table below summarises the impact of a debit or a credit on each type of transaction.
|Debit to increase||Credit to increase|
This summary table will be useful in to know how to post your double entry.
|Category||A debit entry will...||A credit entry will...|
|Asset||Increase an asset||Decrease an asset|
|Expenditure||Increase an expense||Decrease an expense|
|Drawing||Increase drawings||Decrease drawings|
|Capital||Decrease capital||Increase capital|
|Liability||Decrease a liability||Increase a liability|
|Income||Decrease income||Increase income|
What is an accounting equation?
Think about the principle behind double entry: the accounting equation.
- An increase in an asset is a debit, a decrease in an asset is a credit
- An increase in a liability is a credit, a decrease in a liability is a debit
- An item of expense is a debit
- An item of income is a credit
- Drawings are a debit.
Double entry is based on the idea that if you change one of these items, for example, if you receive income (credit), then there has to be an equal change in another item, in order for the equation to still balance, for example, an increase (debit) in the cash asset.
The accounting equation is
Assets - Liabilites = Capital
Capital is the money that belongs to the owner, so it is the amount that the owner invested minus any money that they have taken out of the business (drawings) plus profit made by the business.
What is a double entry bookkeeping example?
For example, let's say we sell something to client A for $55.
- We debit 'customers' and credit 'income'.
- When Client A gets the $55, we debit the bank and we credit the customer.
- So in our cash books, an easy way to remember double entry is to remember that a debit entries go in and credit entries go out.
What was accounting like before double-entry bookkeeping?
The origins of double-entry bookkeeping can be traced back to the Venetian merchant and mathematician Luca Pacioli. In 1494, Pacioli published a treatise on arithmetic, geometry, and proportion entitled Summa de Arithmetica, Geometria, Proportions et Proportionality. This booklet included a section on bookkeeping, which was based on the methods used by Venetian merchants. This system was later adapted by other Italian merchants and became known as the "Italian method".
Before the advent of double-entry bookkeeping, accounting was a very different process. Rather than being a system of recording and evaluating financial transactions, it was more like an individualized and somewhat ad hoc process. Each person kept track of their finances in whatever way they saw fit, and there was no accurate, standardized method for doing so. This made it challenging to compare finances across individuals or businesses since everyone had their way of keeping track of things.
Double-entry bookkeeping changed all that. Establishing a standard method for recording financial transactions made comparisons much more accessible and provided a more accurate picture of a business's financial state. This has made accounting immensely more helpful in helping companies make sound financial reporting.
Also read what is materiality concept in accounting