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Guide to Double-Entry Bookkeeping

Double-entry bookkeeping, a core accounting principle, illustrates that every financial transaction your business undertakes has an equal and corresponding effect.

 

Engaging in activities that bring cash into your business, such as selling a product or attracting an investor, means your business also parts with something, like inventory or equity.


Double Entry Bookkeeping

Utilizing double-entry bookkeeping to monitor the sources and destinations of your funds:

 

  • Enhances the transparency and accuracy of your financial data

  • Reduces the likelihood of bookkeeping errors

  • Assists in making more informed business decisions

 

To properly execute double-entry bookkeeping, you must first understand how business accounts are structured and how debits and credits impact them.

 

What is Double-Entry Bookkeeping?

 

Double-entry bookkeeping is an accounting method that records business transactions as journal entries in a general ledger (or primary accounting document) using debits and credits.

 

Each transaction is documented in at least two accounts in your ledger: a debit to one account and a credit to another. In more complex transactions, multiple entries may be recorded. For example, a sale will:

 

  • Increase your revenue account

  • Decrease your inventory account

  • Generate a tax liability related to the collected sales tax

 

To determine which accounts to debit or credit, let's begin by examining the structure of general ledger accounts.

 

Analyzing the General Ledger

 

A general ledger is typically divided into five primary account categories:

 

1. Assets (what your business owns) encompass items such as cash, inventory, and accounts receivable.

 

2. Liabilities (what your business owes) include items such as loans, taxes, and accounts payable.

 

3. Equity (Assets minus Liabilities) represents elements such as retained earnings and owner's equity.

 

4. Revenue (money coming into your business) includes items such as sales and investment interest.

 

5. Expenses (money leaving your business) include costs such as rent, insurance, advertising, and payroll.

 

By dividing these primary accounts into their corresponding subaccounts (also known as your company’s chart of accounts), you can:

 

  • Record and organize all your business transactions

  • Generate meaningful financial reports

  • Utilize your data to assess business performance and make more informed financial decisions

 

For instance, your balance sheet illustrates the value of your business by detailing what you own (asset accounts) and subtracting what you owe (liability accounts).

 

Meanwhile, your income statement shows your business’s profitability by subtracting your expenses (expense accounts) from your income (revenue accounts).

 

As you remember, with double-entry bookkeeping, each business transaction requires at least two journal entries. If your transaction involves exchanging one asset (cash) for another asset (equipment), you would adjust both your cash and equipment accounts. In summary, double-entry bookkeeping uses debits and credits to record every transaction in at least two accounts. For example:

 

  • When a company receives cash from a customer (increasing assets), the Cash account is debited, and the Revenue account is credited (increasing equity), reflecting the income from sales.

  • When a company pays a supplier (decreasing assets), the Cash account is credited, and

 

To make these adjustments accurately, you must adhere to specific rules governing debits and credits.

 

Debits:

  • Increase asset accounts

  • Decrease liability or equity accounts

  • Decrease revenue accounts

  • Increase expense accounts

 

Credits:

  • Decrease asset accounts

  • Increase liability or equity accounts

  • Increase revenue accounts

  • Decrease expense accounts

 

When transactions are recorded as journal entries in your general ledger, debit entries always appear on the left side, while credit entries are placed on the right.

 

These entries can be summarized and verified in a trial balance worksheet, which displays the debit or credit balances of each business account, as well as the total credits and debits.

 

Here’s a basic example to illustrate how debits and credits are used to create journal entries:

 

You recently paid $2000 for a new business laptop. This transaction increases equipment and decreases cash. To record it in your books, you’d debit your equipment account by $2000 (since the equipment, an asset, is increasing in value) and credit your cash account by $2000 (since cash, an asset, is decreasing in value).

 

The crucial point to remember for maintaining balanced accounts is that every business transaction must be recorded as both a debit and a credit in at least two accounts in your books.

 

This will also ensure the following accounting equation remains balanced:

 

Assets = Liabilities + Equity


This equation is clearly depicted on your balance sheet, with asset accounts listed and totaled on the left side, and liability and equity accounts listed and totaled on the right side.

 

If this equation is ever unbalanced, it indicates an error was made in one of the journal entries.

 

Utilizing Accounting Software

 

Accounting software (such as QuickBooks) simplifies the process of double-entry bookkeeping.


With this software, you can easily:

  • Customize your chart of accounts

  • Record transactions by assigning them to specific accounts

  • Identify when a journal entry is out of balance

 

You can even link your bank feed to your accounting software to eliminate the need for manually importing bank and credit card transactions.

 

Single-Entry vs. Double-Entry Bookkeeping

 

Single-entry bookkeeping is another accounting system for tracking business finances. In this method, there is only one journal entry per transaction, with most entries recording either incoming or outgoing funds.

 

While single-entry bookkeeping is simpler to use than double-entry (since all transactions are recorded in a single ledger), it does not track asset, liability, or equity amounts and is more susceptible to errors.

 

Why is Double-Entry Bookkeeping Essential?

 

Unlike the single-entry method, double-entry bookkeeping offers a comprehensive, three-dimensional view of your finances, making it easier to monitor your company's financial health effectively.

 

The double-entry system provides accountants with the necessary information to create all the major financial statements:

 

  • Income Statements

  • Balance Sheets

  • Cash Flow Statements

  • Statements of Retained Earnings

 

While public companies are legally required to use the double-entry bookkeeping system under Generally Accepted Accounting Principles (GAAP), small businesses with more than one employee should also adopt this method, particularly if they plan to apply for a loan.

 

Double-entry bookkeeping is not only the more accurate accounting method but also the only way to gauge how quickly your business is growing. Additionally, as a more comprehensive and transparent system, it is favored by investors, buyers, and banks. In fact, anyone considering investing in or lending money to your business will be more inclined to do so if you use double-entry bookkeeping.

 

Do you need assistance with understanding, setting up, or managing your business’s double-entry bookkeeping system? Bluemount Backoffice Solutions can help.

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