What Is Double Entry Accounting? (System & Examples)

What Is Double Entry Accounting? (System & Examples) | Accounting Smarts
Charles Hall

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Charles Hall

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May 28, 2021

Are you shopping for accounting software and came across a double-entry accounting system and wonder what it is?

Are you shopping for accounting software and came across a double-entry accounting system and wonder what it is?

Well, you are in the right place, as this post will give you valuable insight into what double-entry accounting is and how the system works.

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Definition of Double-entry Accounting

Double-entry accounting envelopes the basics of all bookkeeping and accounting while also stating that all financial transactions can affect at least two other different accounts in any case. This system satisfies the accounting equation as a double-entry system balances the general ledger by offsetting credits by debits.

The Basics of Double-entry Accounting

In a double-entry accounting system, you must record the transaction in both credits and debits records. This is purely because the offset due to debit will reflect as credit in another. In the end, your goal as an accountant is to ensure that the sum of debits must be equal to the sum of credits.

This system standardizes your accounting process while making it more efficient and accurate to prepare financial statements. Moreover, double-entry accounting improves error detection. There are seven types of accounts used in this system to classify business transactions, and these are.

  • Assets account
  • Equities account
  • Expenses account
  • Gains account
  • Liabilities account
  • Losses account
  • Revenue account

A double-entry accounting system allows you to track changes in all these accounts simultaneously.

The System

A double-entry accounting system helps businesses rationalize their financial transactions and make their bookkeeping more efficient. This way, a company can understand its profits and expenses in a better way.

The balance sheet in a double-entry accounting system represents an expanded version of complex accounts by representing multiple transactions and their details. In this system, the total number of assets of your business equals the total sum of shareholder equity and liabilities.

Moreover, this numerical representation is responsible for demonstrating equalization of all your business capital to their sources.

If you are a business wishing to keep an accurate account of each financial transaction, each transaction must be present in at least two of your accounts. This means a debit of the amount from one account must also reflect a credit amount in another account.

For example, if you have to spend $10,000 on buying a company vehicle. This transaction will show up as a debit from your expense account and show up as an addition in the asset account because your vehicle becomes an asset.

This way, you can ensure that the overall sum of accounts stays in balance, i.e., the records of each debited amount from one must reflect as a credited amount in another account.

Double-entry vs. Single Entry

A single entry accounting system involves recording all the financial transactions of your business such as payroll, expenses, profits, revenues, etc. However, you simply have to maintain a single ledger for all incoming and outgoing money.

In case you are a freelancer, you are probably using such a system already, such as a single spreadsheet, to maintain all your business transactions. It is simple, quick, and convenient, but that is how far the benefit of a single entry system goes.

You spend something, it goes in the single entry sheet, you receive a payment, and that lands in the same sheet. There is no bifurcation of ledgers for the money you spend and money you earn or receive.

On the other hand, a double-entry system not only allows you to categorize all your business transactions but avoid any errors or lost payments. With each transaction mirroring in several accounts, you can make informed decisions about the financial status of your business.

As an accountant using a double-entry system, you will have access to enough data to help create detailed financial statements. These include the following.

  • Income statements
  • Profit and loss statements
  • Balance sheets
  • Statement of your business's retained earnings
  • Statement of your business's cash flows (collectively as well as for each department)

The double-entry accounting systems are nothing short of a revolution in the domain of accounting and bookkeeping. You can even itemize your profits for each financial account. This way, you can keep track of how profitable each of your products and/or service is.

Additionally, you can use the statements to make informed decisions on what does and does not work for your business in terms of monetary benefits. So, if you are looking for a modern accounting tool, a double-entry system is the only solution.

How it Works

Let's have a look at how exactly a double-entry system will work in a real-time business scenario. For instance, you buy a brand new computer for your business for $2000.

Now in double-entry accounting, you will have to make two entries into your general ledger. You traded cash (which is an asset) for a laptop (which is also an asset). Therefore, you will have to adjust both these financial accounts to balance the overall equation.

Simply remember this golden rule, for every debit entry in a double-entry accounting system, there will be an equivalent credit entry to balance the equation.

Assets in Double-entry Accounting System

The assets represent all business equity and liabilities. This is known as the accounting equation and is the foundation of any double-entry accounting system. The goal is to maintain a balanced equation. If your business equation ever goes out of balance, this means that the bookkeeper has made an error somewhere while entering the transactions.

So, let us consider the same example as above for buying a computer. In this transaction, the asset side of the equation decreases by $2,000, whereas the asset side increases by $2,000.

Now let us suppose that you bought five computers worth $2,000 each bringing your total to $10,000, but you bought it on credit. In this scenario, your business assets have increased by $10,000. However, it will be your accounts payable this time that will increase by $10,000 this time because you purchase the computers on credit.

If your accountant makes the mistake of entering $10,000 in a debit account, when you never spend that amount of money, this will end up showing you $10,000 in access (mistaken for a profit). So, this is what your actual ledger must depict to get it right.  

In this case, both your assets as well as your liabilities increase by $10,000. Therefore, both accounts must reflect the transaction so the financial statement/equation can remain in balance.

Breaking Down the Double-entry Accounting System Sheet

While it may take some time to understand how the credit and debit system works in a double-entry accounting system, it makes things easier in the long run. Here is how both credit and debit in double-entry accounting works to help you get started.

Credits

  • Any increase in your business's equity or liability account.
  • Decrease in your asset account
  • Increase in revenue
  • Decrease in your expense account

Moreover, the credit record always goes on the right side of the balance sheet

Debits

  • Decrease in business's equity or liability
  • Increase in your asset account
  • Decrease in revenue
  • Increase in the expense account

Debits go on the left side of the balance sheet.

Is Double-entry Accounting System Good for Business

In case you are a freelancer or startup with limited inventory, assets, equity, expenses, and employees, then double-entry accounting might be too complex. A double-entry system is worth it if you are a small to medium-sized business looking for a three-dimensional view of your financial operations.

This will give you a birds-eye view of your monetary trail in terms of where the money is coming in from and where it is going out to. You can then co-relate this information by the reconciliation of your financial statements.

This way, you will also gain valuable insight into the financial health and profitability of each product, service, department as well as overall business. Moreover, you will be able to make better-informed decisions based on the numbers, data, graphical charts, and financial statements enabled by a double-entry accounting system.

Other benefits of the double-entry system include lowering the risk of human-made bookkeeping errors and increasing the transparency of a business's finances. Additionally, it adds another accountability protocol in your business operations to ensure the validity of each transaction.

Best Double-entry Accounting Software

Most businesses prefer using a double-entry system for their accounting and bookkeeping needs. Do not feel intimated by the multiple functionalities of these systems. Most of them come with a user-friendly interface and mobile apps to help you carry your financial data from wherever and whenever you want.

That said, here are the top five double-entry accounting software solutions you can.

However, you must first evaluate your business needs and the complexity of your company's bookkeeping and accounting operations. You can even buy add-ons to carry out several other functions related to the accounting area. For example, there are add-ons available to create employees' and vendors' portfolios and even carry out payroll operations using a double-entry accounting system.

Charles Hall

Charles Hall

Charles has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor international accounting firms. He has worked as a controller and as a COO for small to medium sized companies.

Learn more about Charles Hall