Bookkeeping is the process of recording, storing, and retrieving financial transactions. Two main types of bookkeeping systems exist single entry and double entry.
Single-entry bookkeeping is the simplest form of bookkeeping. Transactions are only recorded once in a journal. This system is suitable for small businesses with simple transactions.
Double-entry bookkeeping is a more complex system where transactions are recorded twice in different accounts. This system provides more accurate financial information and suits businesses with more complex transactions.
This article will take a closer look at the double-entry bookkeeping system.
What Is a Double Entry Bookkeeping System?
A double-entry bookkeeping system is a system of bookkeeping where every transaction is recorded in at least two different accounts.
This system provides a way to check the accuracy of your bookkeeping, as every transaction will affect at least two different accounts.
Let’s say a company sells a product for $1,000 in cash. This transaction would require two entries:
Debit Cash Account for $1,000 (increase in asset account)
and Credit Sales Account for $1,000 (increase in revenue account)
In this example, the debit entry increases the company’s cash balance, while the credit entry increases its revenue. The accounting equation records the transaction, which ensures that the total debits always equal the total credits.
How Does the Double Entry Bookkeeping system work?
Double-entry bookkeeping records each financial transaction in at least two different accounts. For example, when a business makes a sale, the corresponding entries would be a debit to the Accounts Receivable account and a credit to the Sales Revenue account.
The objective of this system is to ensure that each transaction is recorded in at least two places so that it can be easily reconciled. Businesses can track their financial activity more precisely and generate more accurate financial statements.
To record transactions in double-entry bookkeeping, businesses use ledgers and journals. Ledgers store information about specific accounts, such as Accounts Receivable or Sales Revenue.
Journals store information about specific transactions, such as the date, amount, and transaction description.
When recording transactions in ledgers and journals, businesses must follow the rules of debits and credits. The rules of debits and credits dictate which side of the ledger each entry must be recorded on.
For example, when recording a sale in the ledger, the Accounts Receivable account must be debited, and the Sales Revenue account must be credited.
The rules of debits and credits can be summarized as follows:
– Assets are always debited
– Liabilities are always credited
– Equity is always credited
– Revenues are always credited
– Expenses are always debited
Example Of Double Entry Bookkeeping System
Here’s an example of a simple double-entry bookkeeping system:
| Date | Account Debited | Account Credited | Amount |
|---|---|---|---|
| 1/1/2022 | Cash | Common Stock | $10,000 |
| 1/5/2022 | Rent Expense | Cash | $1,000 |
| 1/10/2022 | Supplies | Accounts Payable | $500 |
| 1/15/2022 | Accounts Payable | Cash | $500 |
| 1/31/2022 | Salaries Expense | Cash | $2,000 |
| 1/31/2022 | Rent Expense | Cash | $1,000 |
The table records each transaction as a debit and a credit. The debited account is listed on the left, and the credited account is on the right. The amount of each transaction is also recorded.
For instance, the business issued $10,000 worth of common stock on January 1st, 2022. This transaction is recorded as a credit to the Common Stock account and a debit to the Cash account.
On January 5, 2022, the company paid $1,000 in rent. This transaction is recorded as a debit to the Rent Expense account (an expense account) and a credit to the Cash account.
On January 10, 2022, the company purchased $500 in supplies on credit. This transaction is recorded as a credit to the Accounts Payable account and a debit to the Supply account.
On January 15, 2022, the company paid $500 to settle the accounts payable balance. This transaction is recorded as a debit to the Accounts Payable account and a credit to the Cash account.
The business paid $1,000 in rent and $2,000 in compensation on January 31, 2022. These transactions are recorded as a credit to the Cash account and a debit to the Salary Expense account and the Rent Expense account.
Double-entry bookkeeping ensures that its accounting records are accurate and that the accounting equation (Assets = Liabilities + Equity) remains balanced.
The advantage of a double-entry bookkeeping system
The double-entry bookkeeping system has several advantages over other methods of accounting.
Firstly, spotting errors and omissions in a double-entry bookkeeping system is much easier. Each transaction has two entries so that any errors will be immediately apparent.
Secondly, the double-entry bookkeeping system provides a much more accurate picture of your financial affairs. This is because all of your transactions are logged twice, reducing the possibility of vital information being overlooked.
Thirdly, the double-entry bookkeeping system lets you prepare your accounts more quickly and easily. This is because the system already contains all the information you need which saves you time.
Fourthly, the double-entry bookkeeping system is much more flexible than other accounting methods. You can tailor the system to suit your needs and requirements.
Finally, the double-entry bookkeeping system is much more secure than other accounting methods. All of your transactions are logged twice which makes it difficult for someone to alter your records.
The Disadvantage of the double-entry bookkeeping system
While the double-entry bookkeeping system offers several advantages, there are also some potential disadvantages.
One of the most significant potential disadvantages is that it can be more time-consuming to maintain accurate records using double-entry bookkeeping.
This is because every transaction must be recorded in two places to keep the books balanced. This can make the bookkeeping process more complex and time-consuming than a single-entry system.
Another potential disadvantage is that it can be easy to make mistakes when recording transactions using double-entry bookkeeping.
If just one number is entered incorrectly, it can throw off the whole system and create inaccurate records. This can lead to problems when reconciling your books or preparing financial statements.
Of course, these potential disadvantages should encourage you to use double-entry bookkeeping for your business. With proper training and a little practice, you should overcome any challenges and reap this system’s many benefits.
Related: Accounting tips for small businesses
How to implement a double-entry bookkeeping system?
Regarding bookkeeping, the double-entry bookkeeping system is the most accurate and reliable method.
This system involves recording each transaction in two separate accounts to provide a complete picture of the financial activity of a business.
To implement this system, businesses must maintain two sets of books – one for assets and one for liabilities. Here’re a few steps to implement a double-entry bookkeeping system:
Understand the basics of double-entry bookkeeping:
In double-entry bookkeeping, each financial transaction is recorded with two entries: a debit and a credit.
The accounting equation, which states that Assets = Liabilities + Equity, forms the basis of this system. The equation must remain balanced, meaning the total debits must always equal the full credits.
A debit is an entry on the left side of an account, indicating an increase in assets or a decrease in liabilities or equity. Contrarily, a credit entry is one that appears on the right side of an account and denotes either a rise in obligations or equity or a fall in assets.
Select accounting software:
Choosing accounting software that meets your business needs is crucial. Various options are available, including QuickBooks, Xero, and FreshBooks. Consider factors like the size and complexity of your business and budget before deciding.
Create a chart of accounts:
The chart of accounts is a list of accounts used to record financial transactions. Each account represents a category of financial transactions, such as cash, inventory, accounts payable, and accounts receivable.
Creating an accurate chart of accounts is crucial to ensure all transactions are recorded correctly. The chart of accounts should include a unique account number, account name, and account type (e.g., asset, liability, equity, income, expense).
Record transactions:
Record each financial transaction using double-entry bookkeeping principles. You need to record a debit and a credit for each transaction. The accounts used for recording will depend on the nature of the transaction.
For example, if you purchase inventory using cash, you must debit the inventory account (an asset account) and credit the cash account (an asset account).
In contrast, if you purchase inventory on credit, you must debit the inventory account and credit the accounts payable account (a liability account).
Reconcile accounts:
Reconciliation involves comparing accounting records to bank or credit card statements to ensure they match. Reconciliation identifies any errors or discrepancies in accounting records. Regular reconciliation is crucial for maintaining accurate accounting records.
To reconcile accounts, compare transactions recorded in accounting software to those in bank or credit card statements. Investigate and correct any discrepancies.
Generate financial statements:
Financial statements like balance sheets, income, and cash flow statements provide a snapshot of your business’s financial health. After recording all transactions and reconciling accounts, generate these statements to make informed decisions.
The balance sheet shows assets, liabilities, and equity at a specific point in time. The income statement shows revenue and expenses over a period. The cash flow statement shows cash inflows and outflows over a period.
Double-entry bookkeeping is a powerful system of accounting that provides accurate financial information. It can be a useful tool for managing your company’s finances with the correct software and assistance.
What is the difference between a single-entry and double-entry bookkeeping system?
A single-entry bookkeeping system only records transactions in one account, whereas a double-entry bookkeeping system records them in at least two accounts.
In double-entry bookkeeping, every transaction affects at least two ledger accounts. The accounting equation is the foundation of the double-entry bookkeeping system. This equation states that assets are equal to liabilities plus equity. The equation must always balance.
Under the single-entry bookkeeping system, business transactions are not analyzed regarding their impact on different ledger accounts. Small businesses and individuals with simple financial affairs mainly use this system.
In contrast, the double-entry bookkeeping system records each business transaction in at least two ledger accounts. This system provides a more detailed analysis of business transactions and is used mainly by large businesses.
Also Read:
