What Does the Term “Double Entry Bookkeeping” Mean in Accounting
For hundreds of years, double-entry bookkeeping has been the standard method of accounting for financial transactions. Every cloud-based bookkeeping system, banking system, and reporting system used by organisations throughout the world is built on it.
It lets a company to keep track of all of its transactions and see how it is doing in terms of profitability, cash flow, and growth. It also covers all of a company’s continuous reporting and submission needs — VAT returns, annual accounts, tax returns, and so on all rely on double-entry bookkeeping.
What are the fundamentals of double-entry accounting?
Double-entry bookkeeping is based on the simple notion that every transaction has two equal and opposite parts. If you sell things, for example, your cash balance will rise while your stock levels will decrease. This is why accountants talk about balancing things and use the term “balance sheet” in their accounts.
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Debits and credits are the terms used to describe the entries that occur from double entry bookkeeping. Every accounting transaction has two sides, and these are the two sides of every accounting transaction.
The accounting records of any company, no matter how simple or complex, will be made up of these double entries. These transactions can then be summed up in a general ledger, which represents the total of all transactions, broken down by kind.
When entering these journal entries into a general ledger, debit entries go on the left and credit entries go on the right. These are summed together in a trial balance, which displays account balances by type as the sum of all linked debits and credits. Your trial balance should reflect that the overall credit balance is equal to the overall debit balance if everything is done correctly.
Who should use double-entry bookkeeping?
Simply said, all organisations will be required to employ double-entry accounting. It is the only method to assure that financial data is complete and accurate, and it will support all of the business’s ongoing reporting functions.
Some business owners do all of their double-entry accounting on their own, but in most situations, bookkeepers or local accountant for small business are brought in to assist in the setup and operation of appropriate bookkeeping systems.
Knowing how to conduct double-entry bookkeeping
The goal of double-entry bookkeeping is to construct a set of financial statements based on the trial balance (profit and loss statement and balance sheet). The profit and loss statement displays revenue, costs, and profit/loss for a specific time period. The balance sheet is a record of a company’s assets, liabilities, and equity across time.
The following formula underpins the double-entry bookkeeping system:
Assets = Liabilities + Equity
The accounting equation is what it’s called. The profit or loss made over time, including the present quarter, is included in the equity section of a balance sheet.
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What is the profit and loss statement made up of?
- Profit/loss
- Revenue
- Costs
What is a double-entry bookkeeping balance sheet made of?
- Equity
- Assets
- Liabilities
A cheat sheet for double-entry accounting
It might be difficult to understand debits and credits, as well as how each type of company transaction affects each account and financial statement. Here’s a cheat sheet on how debits and credits work in the double-entry accounting system to make things a little easier.
Debits:
- Increase the value of an asset, or lower the value of an obligation or equity account (such as owner’s equity).
- Increase the amount of money in an expense account.
- Reduce revenue
- Are recorded on the left side
Credits:
- Increase the amount of money in a liability or equity account, or decrease the amount of money in an asset account.
- Reduce the amount of money in an expense account.
- Boost your revenue
- Are recorded on the right side
Why should you utilise a double-entry accounting system?
You can accurately record your financial information by documenting both credit and debits in a double-entry accounting system. Every firm must keep a tight check on its income as well as its expenses, which is why double-entry accounting is required. Companies are also better equipped to anticipate future spending when they have all of this information.
Should I use double-entry?
Single-entry accounting may be sufficient for your accounting needs if your company is a simple sole proprietorship with no inventory, no debts, only one employee, and few accounts to keep track of.
Most accountants will strongly advise you to move to double-entry bookkeeping if your business is any more complicated than that.
Why? Double-entry accounting gives you a more comprehensive, three-dimensional picture of your money than single-entry accounting ever could.
You may eventually compile that information into financial statements, which provide you insights into the profitability and health of various sections of your organisation, because you’re tracking where your money comes from and where it goes. That’s a gain because financial statements can assist you in making better financial decisions in the future.
Double-entry accounting also reduces the risk of bookkeeping errors, improves financial transparency, and provides a level of accountability to your organisation that single-entry accounting cannot.
If you want investors, banks, and possible buyers to take your company seriously, you should use double-entry accounting.
FURTHER READING: What Does the Term “Debentures” Mean in Accounting