What Is Double-Entry Bookkeeping? A Simple Guide for Small Businesses
Double-entry bookkeeping is an accounting system where every transaction is recorded in two accounts: a debit to one account and a credit to another. For example, if a business takes out a $5000 loan, assets are credited $5000 and liability is debited $5000. The $5000 is both an increase in cash and an outstanding debt, according to The Balance.
In this article, we’ll cover:
What Is Double Entry Bookkeeping?
The definition of double-entry bookkeeping is an accounting method where a transaction is equally recorded in two or more accounts. A debit is made in at least one account and a credit is made in at least one other account.
The total debits and credits must balance, meaning they have to account for the total dollar value of a transactions. A transaction for $1000 must be credited $1000 and debited $1000.
- For example, a copywriter buys a new laptop computer for her business for $1000. She credits her technology expense account $1000 and debits her cash account $1000. This is because her technology expense assets are now worth $1000 more and she has $1000 less in cash.
Debits always increase asset or expense accounts and decrease liability or equity accounts. Credits always decrease asset or expense accounts and increase liability or equity accounts, according to Accounting Tools.
The Accounting Equation
This above becomes clearer when we look at the accounting equation, one of the fundamental principles of accounting. Both sides of this equation must be the same. If they’re not, there’s a mistake in the books.
Here’s the equation:
Assets = Liabilities + Equity
So, if assets increase, liabilities must also increase so that both sides of the equation balance.
- For example, an e-commerce company buys $1000 worth of inventory on credit. Assets (the inventory account) increase by $1000 and liabilities (accounts payable) increase by $1000. So both sides of the accounting equation are the same. This is reflected in the books by debiting inventory and crediting accounts payable.
Who Uses Double-Entry Bookkeeping
Public companies must use the double-entry bookkeeping system by law. The Financial Accounting Standards Board (FASB), a nongovernmental body, decides on the generally accepted accounting principles (GAAP). Public companies have to follow any rules and methods outlined by GAAP.
Small businesses with more than one employee or looking to apply for a loan should also use double-entry bookkeeping. This system is a more accurate and complete way to keep track of the financial situation of a company and how fast it’s growing.
How To Do Double-Entry Bookkeeping
Double-entry bookkeeping is usually done using accounting software. Software lets a business create custom accounts, like a “technology expense” account to record purchases of computers, printers, cell phones etc. You can also connect your business bank account to make recording transactions easier.
Accounting software also easily generate reports which makes getting ready for tax time and year end much simpler.
You can hire an accountant to do this work. Or FreshBooks has a simple accounting solution for small business owners with no accounting background.
People also ask:
- What Is the Double Entry Concept in Accounting?
- What Are the Rules of Double Entry Bookkeeping?
- Why Is Double Entry Bookkeeping Important?
What Is the Double Entry Concept in Accounting?
There are three major components to the double entry concept in accounting, according to Accounting Coach. They are:
- Every business transaction has to be recorded in at least two accounts in the books.
a. For example, money received from a business loan will increase its cash account (an asset) and increase its loans payable account (a liability).
- For each transaction, the total debits recorded must equal the total credits recorded.
a. For example, if a company pays $20 for a website domain, the cash account will decrease $20 and the advertising expenses account will increase $20.
- Total assets must always equal total liabilities plus equity (net worth or capital) of a business. Both sides of this equation must be the same, which means it’s said to balance.
a. Assets = Liabilities + Equity
b. For example, a business loan means an increase in liability which will decrease the business’s net worth (equity). This means that the right side of the equation will still balance with assets.
What Are the Rules of Double Entry Bookkeeping?
The Financial Accounting Standards Board (FASB) governs the generally accepted accounting principles (GAAP), which are the official rules and methods for double-entry bookkeeping.
Rules for Debits and Credits
- Recorded on the left of a ledger sheet
- Increase an asset account or decrease an equity or liability account
- Decrease revenue
- Increase expense accounts
- Recorded on the right of a ledger sheet
- Decrease an asset account or increase an equity or liability account
- Increase revenue
- Decrease expense accounts
Rules for Accounts
Certain accounts must always be used in double-entry accounting. These include:
- Asset accounts record the monetary value of what a business owns, such as the money in its checking account to tools to buildings
- Liability accounts record the amount a business owes on things like lines of credit or a mortgage
- Expense accounts record what you’ve spent money on, such as payroll and advertising
- Income accounts record money coming in, like revenue
Why Is Double Entry Bookkeeping Important?
Very small, new businesses may be able to make do with single-entry bookkeeping. But double-entry bookkeeping delivers many advantages. This article compares single and double-entry bookkeeping and the pros and cons of both systems.
Delivers a Complete Financial Picture
Small businesses can use double-entry bookkeeping as a way to better monitor the financial health of a company and the rate at which it’s growing.
In fact, a double-entry bookkeeping system is essential to any company with more than one employee or that has inventory, debts or several accounts.
Businesses that meet any of these criteria need the complete financial picture double-entry bookkeeping delivers. This is because double-entry bookkeeping can generate a variety of crucial financial reports like a balance sheet and income statement, according to Bench Bookkeeping.
Helps Companies Make Better Financial Decisions
Double-entry bookkeeping’s financial statements tell small businesses how profitable they are and how financially strong different parts of their business are. You can see how you’ve spent money and how your business is doing. Tthis helps a company make better financial decisions in the future.
Reduces Bookkeeping Errors
When you generate a balance sheet in double-entry bookkeeping, your liabilities and equity (net worth or “capital”) must equal assets. If they don’t, you know your books are wrong. This failsafe tells businesses if their journal entries are wrong.
The double-entry system is also a more generally transparent way to keep your books and helps keep businesses accountable.
Preferred By Investors, Banks, Buyers
Because the double-entry system is more complete and transparent, anyone considering giving your business money will be a lot more likely to do so if you use this system.
Double-entry bookkeeping produces reports that allow investors, banks and potential buyers to get an accurate and full picture of the financial health of your business.
Accountants and bookkeepers can do a small business’s double-entry bookkeeping. Or FreshBooks has a simple online accounting solution that lets small business owners do it themselves and makes keeping the books easy.