What is double-entry accounting?
Double-entry and single-entry bookkeeping are both practices used in accounting to record transactions and keep the company's accounts up to date in the trial balance. Double-entry accounting refers to how business transactions are recorded in both debits and credits as separate accounts in the accounting ledger. In other words, double-entry accounting refers to a system where every transaction is recorded twice in the books of the company. This approach creates a clear distinction between the two sides of a transaction, which is essential for establishing a solid accounting system for business reporting, tax compliance and analysis.
Double-entry accounting is a practice used by accountants to ensure that books balance out. Each transaction must have a debit entry and a credit entry and the total of the debit entries must equal the total of the credit entries.
Double entry bookkeeping: examples
The following are examples of transactions that use double-entry accounting:
A business pays $500 cash for merchandise inventory:
- The debit goes to an asset account called Cash and Credit (or Accounts Receivable),
- The credit goes to an inventory asset account called Merchandise Inventory.
A business receives $600 cash from a customer on a credit sale, which is recorded as follows:
- Debit Cash and Credit Account
- Credit Accounts Receivable Account (for the amount received).
What are debits and credits?
Double entry accounting is based on the idea that for every account, two entries should always be made: one to debit and one to credit.
A debit is a left-hand side account number and a credit is a right-hand side account number. The left-hand side of an entry always means "what you owe," so debits increase amounts owed on your balance sheet, such as inventory or accounts payable. The right-hand side of an entry always means "what you own," so credits decrease amounts owed on your balance sheet, such as accounts receivable or cash balances. Here's where things get complicated: not all debits are increases and not all credits are decreases.
Debits increase asset and decrease liability, Credits decrease assets and increase liabilities
Double-entry accounting is an accounting system that has two different types of accounts: Assets, Liabilities, and Equity.
- Assets are things that a company owns, such as cash, inventory, buildings and equipment.
- Liabilities are obligations of the company; they represent money that the company owes to others. Liabilities include accounts payable, accounts receivable, and long-term debt (such as a mortgage).
- Stockholders’ equity represents the total amount of money invested in a company by its owners (including both common and preferred stock). This investment is shown on the balance sheet as “Capital Stock.”
Assets are recorded on the left side of the ledger, while liabilities and equity are recorded on the right side.
Debits and credits are two sides of the same coin. A debit increases the balance of an asset account and decreases the balance of a liability account, while a credit does the opposite. In other words, when you make a journal entry, you are either increasing an asset or decreasing an expense or liability. You are not allowed to increase both at the same time; you must choose one or the other.
You buy a new office chair with your credit card, which has a balance of $2,000 at the time of purchase. The transaction debits your asset account "Office Furniture" for $200 (the amount of the purchase) and credits your liability account "Credit Card Balance" for $200 (the amount of the purchase).
Debits increase stockholders' equity accounts, and vice versa for credits
When you debit a stockholders' equity account, you increase its balance; when you credit a stockholders' equity account, you decrease its balance.
The reason that debits increase stockholders' equity accounts is because they're positive numbers and stockholders' equity accounts are represented by negative numbers—it's just like adding positives to negatives!
If you have a balance sheet which shows $10,000 in stockholders' equity, and then you buy $5,000 worth of goods on account, the new balance sheet will show you have $15,000 in stockholders' equity (because you just increased it by $5,000). The assets side of the balance sheet will show the $5,000 owed to your supplier as an asset (because that's what it is), but the liabilities side won't change because there isn't any liability from this purchase yet.
Keep the equation in balance by matching debits to credits
When you're working with a company's general ledger, it's important to keep the equation in balance. When you debit an account, you must also credit another account. If you're using the accrual method of accounting for inventory, when you enter a journal entry, you have to keep these two sides in balance by matching debits to credits. If the two sides of the equation are out of balance, then you have an error or omission in your records.
To match debits to credits, follow these steps:
- Write down the name of the account or related accounts that are affected by the transaction.
- Identify what type of journal entry is required for this transaction (debit or credit). If there are multiple transactions within this journal entry, write down each one separately as well.
- If there are multiple transactions involved with one journal entry and they both involve debits and credits to different accounts.
Double-entry accounting is one of the oldest methods of recording business transactions. Most accounting software use this method to ensure that books balance out. For even more efficiency, most accountants use an accounting automation solution. These tools detect and transcribe the accounting entries directly into the appropriate debit and credit accounts.
