Every business requires accounting to keep track of its earnings and expenditures. Furthermore, it provides the basis for financial analysis that stakeholders like management and investors can use to make business decisions. Accounting systems are primarily divided into two categories: Single-entry and Double-entry systems.
In the accounting world, double-entry systems are most widely used due to their many advantages over single-entry systems. In the sections following, we will discuss everything you need to know about the double entry system.
What Is Double Entry Accounting?
Double entry accounting is a method of keeping track of cash movement and accurately recording the impact of transactions. In double-entry accounting, balancing the accounts is the goal, and the system’s foundation is the accounting equation that states that assets have to equal liabilities plus equity.
While recording every transaction, the equation must remain balanced. Whenever a transaction is recorded in double-entry accounting, at least two account changes must be associated with it―when you credit one account, you must debit another account.
Credits are entries recorded on the right side of the accounting ledger, while debits are entries recorded on the left side.
- Debit → The entry on the left
- Credit → The entry on the right
- Debit → Decreases liability and equity accounts, increases assets
- Credit → Increases liability and equity accounts, decreases assets
General ledgers, also called T-accounts, track debits and credits, reducing the possibility of errors.
A company’s cash account is debited when it receives cash (” inflow”). Cash accounts are credited when companies pay out cash (“outflows”).
- Debit to asset → When a debit impacts the asset account’s balance positively, the asset account, referred to as the left side of the ledger, would be debited.
- Credit to asset → The right side of the ledger will be credited if the impact on the asset account’s balance is a reduction.
For liability and equity accounts, debits and credits are reversed. Balance sheet equations (the accounting ledger) cannot remain balanced without offsetting entries in the general ledger.
A Double-Entry Accounting System Accounts
Accounts in double-entry accounting are divided into seven types:
- Asset account: An asset is anything owned by a company with either current or future monetary value, for example, cash, payments, supplies, tools, and equipment (PP&E).
- Liabilities account: This is a record of the liabilities owed by the company to third parties, which can include accounts payable, accrued expenses, notes payable, or debts.
- Equity account: Holds records of capital invested by owners, investments, and earnings retained by the company.
- Revenue account: In the revenue account, a company tracks all sales it generates by selling its goods and services.
- Expenses account: Expenses account includes all business expenses, such as rent, electricity bills, employees, and salaries.
- Gains account: Gains accounts are non-core to a company’s operations but provide positive results, such as selling an asset for a profit.
- Losses account: This account represents a negative impact on a company’s core operations, e.g., loss from a sale, write-down, or write-off.
Debit and Credit Entries — Impact on Accounts
A debit or credit entry has a different impact on each type of account, as shown in the chart below.
| Type of Account | Debit | Credit |
| Asset | Increase | Decrease |
| Liabilities | Decrease | Increase |
| Equity | Decrease | Increase |
| Revenue | Decrease | Increase |
| Expense | Increase | Decrease |
Lastly, it’s crucial to dispel the misconception that debits are good and credits are bad. Depending on the account and the situation, it may or may not be possible. A debit increases a company’s asset account, such as its cash account. Generally, this is a positive development. However, the negative aspect of debits is that they also increase expenditures, which may be viewed as a negative.
How Does Double Entry Bookkeeping Work?
Double-entry accounting involves four key stages that need to be followed to establish and use it. It begins with creating accounts to record transactions and ends with generating financial statements with the account data. The stages are:
- You need to create a chart of accounts so that you can record transactions using all the general ledger accounts in your company. It includes all the accounts for each type: assets, liabilities, equity, revenue, expenses, etc.
- Make sure that all transactions are debited and credited equally to reflect their substance. Any monetary unit can be used for debits and credits.
- In accordance with the accounting equation, every transaction must have two components (debits and credits). It is often made easier by accounting software.
- Use double-entry accounting to generate financial statements. Double-entry accounting systems create the company’s trial and final balance by combining the net account totals at the end of each accounting period. Financial statement line items are derived from the final adjusted balances. Using accounting software, you can automate these processes and integrate them.
What Is An Example of Double Entry For a Business?
The following table shows an example of the double-entry of transactions in a journal.
| Sl. No. | Date | Particulars | Debit (Dr) | Credit (Cr) |
| 1 | 1/6/2020 | Salary
Cash A/c (Being salaries paid) |
30,000 |
30,000 |
| 2 | 5/6/2020
|
Electricity Bill
Cash A/c (Being electricity bill paid) |
2,000 |
2,000 |
| 3 | 8/6/2020 | Vehicle
BankA/c (Being vehicle purchased) |
70,000 |
70,000 |
The first entry in the above table is the salary entry. Since salary is a nominal account, all expenses are debited, and cash is credited since cash payment reduces the asset.
Following that is the payment of the electricity bill entry. The electricity bill is a nominal account, so its expense is debited, and its credit is applied to the cash account.
The third entry shows the business’s purchase of a vehicle. A vehicle is an asset and a real account, so it is debited for its incoming value (vehicle) and credited for the cash paid through a bank account.
As shown in the examples above, the transactions are entered twice for each account as per the debit and credit rules.
When Should You Use Double Entry?
Depending on the complexity of your business, single-entry might suffice if you only have one employee, no inventory or debts, and not many accounts to manage. However, a double-entry system is strongly recommended if your business is more complex than that.
What is the reason? Even though single-entry accounting is easier to implement, it has significant disadvantages compared to double-entry accounting. As a result of the lack of a balanced method of control, single-entry accounting is more susceptible to errors, specifically duplications, and omissions.
Furthermore, single-entry accounting cannot provide a complete picture of a company’s financial health. In this system, only cash inflows and outflows are recorded, identifying when cash is available versus when it is actually earned.
Additionally, it doesn’t include credit sales. As a result, single-entry accounting requires extra effort during the closing process to produce balanced financial statements. Finally, single-entry accounting is not suitable for public companies since it does not comply with GAAP (Generally Accepted Accounting Principles.)
With double-entry accounting, you can see your finances from a more complete and three-dimensional perspective than with single-entry accounting. The information you collect about your money can then be used to construct financial statements since you are keeping track of where it comes from and where it goes. As a result, you will get a comprehensive view of how your business is doing in terms of profitability and health. The benefit of accurate financial statements is that you can make better decisions about future purchases.
In addition to reducing the risk of bookkeeping errors, double-entry accounting also increases financial transparency. It gives your business a layer of accountability it does not have when it comes to single-entry accounting. You should use double-entry accounting if you want investors, bankers, and potential buyers to take your business seriously.
Are There Any Cons to Double Entry Accounting?
Each system has its own cons and pro, and double entry systems are no exception. A few of the cons of double entry are as follow:
- Not For Small businesses: Typically, small businesses keep simple accounting records, such as revenue and expenses, and calculate profit and loss based on expense and revenue vouchers at the end of the month or year. Alternatively, double-entry accounting requires many books that are unsuitable for small businesses.
- Costly maintenance: Since double entry systems maintain separate books of accounts for every transaction, employers hire bookkeepers or accountants to keep track of these books for preparing financial reports, which increases cost.
- Complicated system: Accounts maintenance in this system requires the company’s owner to be knowledgeable about accounting and bookkeeping. Profit and loss accounts are not calculated properly if the owner does not know about the double entry system. In this case, business owners hire an accountant, which is also a complicated process.
- Corrective action is difficult: Most of the time, the transactions are recorded or adjusted at the end of the accounting year and affect the following accounting year as well. You will have a harder time adjusting these transactions if you can’t track them.
- Increase in book size: Due to the need to record every transaction twice, the size of books will increase, or electronic data will require a more powerful computer to handle.
Should I Make Sure My Bookkeeper Is Following Double Entry?
A double entry accounting system reduces errors and increases the possibility of your books balancing. Double entry bookkeeping offers many advantages to companies as it improves financial reporting and prevents fraud. So yes, you should make sure your bookkeeper is following double entry.
The double-entry system lets you maintain your accounts in detail, which helps you control your business. Furthermore, it will help you make better financial decisions by showing how profitable and financially strong different parts of the business are.
With a double-entry bookkeeping system, you can accurately record your financial information by comparing credit and debit transactions from the previous year. By using double-entry bookkeeping, you can track the business’ income and expenses. You can also forecast future spending more accurately if you have all this information at your fingertips.
Conclusion
It is an ideal choice for any business to have a double-entry system. You will have much greater clarity about your business transactions if you opt for a double-entry system, even if you are new to the game. Despite being complex at times, the system provides greater clarity to all stakeholders.
Using a double-entry system of accounting will enable you to find and fix errors quickly. Furthermore, if you follow this system throughout your business journey, you can make all types of financial statements easily.
Your business plans will be able to take shape more clearly once you adopt this system. If you want to focus on growing your business instead of taking care of your bookkeeping, EcomBalance is the best option. Find out how EcomBalance can help you with your financial books.
About EcomBalance
EcomBalance is a monthly bookkeeping service for eCommerce companies. EcomBalance handles your bookkeeping and sends you a Profit and Loss Statement, Balance Sheet, and Cash Flow Statement by the 15th of each month. EcomBalance also has a sister company, AccountsBalance, that caters to agencies, software companies, coaches, and other online companies.
