Double-entry bookkeeping: What it is and why its important for small businesses

Assets (the inventory account) increase by $1,000 and liabilities (accounts payable) increase by $1,000. Accounting is an art of recording, classifying and summarizing the transactions of financial nature measurable in terms of money and interpreting the results thereof. Two methods for accounting are Single Entry System and Double Entry System.

• Most modern accounting software has double entry concepts already built-in.
• Are you a small business owner who employs more than one worker, or is looking to apply for a loan?
• This equation means that the total value of a company’s assets must equal the sum of its liabilities and equity.
• Most accounting software automatically performs double-entry accounting behind the scenes.
• This method provides a more complete picture of a business’s finances, and is typically used by larger businesses.

A business transaction is an economic event that is recorded for accounting/bookkeeping purposes. In general terms, it is a business interaction between economic entities, such as customers and businesses or vendors and businesses. Since the vehicle is an asset and a real account, the incoming asset (vehicle) is debited, and the cash paid through a bank account for the vehicle is credited. The accounting and book-keeping process measures, records and communicates day to day financial activities.

When Lucie purchases the shelving, the Equipment sub-ledger would only show half of the entry, which is the debit to Equipment for $5,000. Sole proprietors, freelancers and service-based businesses with very little assets, inventory or liabilities. If you’ve previously used a single-entry system, you may be wondering how to go about switching to a double-entry system. Most modern accounting software has double-entry concepts already built in. Double-entry bookkeeping can appear complicated at first, but it’s easy to understand and use once the basic concepts have been learned.

Double entry accounting FAQ

This means that the sum of all Debit accounts must be equal to the sum of Credit accounts. This method of accounting and book-keeping results in the accurate depiction of financial statements. Thus, it also lowers the rate of errors by detecting them on a timely basis.

The general journal is an initial record where accountants log basic information about a business transaction, such as when and where it occurred, along with the total amount. Each of these recorded business transactions are referred to as a journal entry. As a small business owner, knowing which accounting practices you should use can be confusing. However, you must remember the fundamental accounting principles for your business’s finances. The balance sheet is one of the three most important financial documents for any business owner.

• Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.
• Double-entry bookkeeping has been in use for at least hundreds, if not thousands, of years.
• It offers greater accuracy, comprehensive financial analysis, and adherence to generally accepted accounting principles and standards.

This period marked a massive transformation in the business world, characterized by more extensive and complex business structures. The double-entry system of accounting or bookkeeping means that for every business transaction, amounts must be recorded in a minimum of two accounts. The double-entry system also requires that for all transactions, the amounts entered as debits must be equal to the amounts entered as accounting for non credits. The total debit and credit sides of all general ledger accounts should always be equal in double entry accounting. Obviously, single-entry accounting is much simpler than double-entry, but it’s also much less accurate. And since it doesn’t break down your cash flow into categories like expenses, assets, and equity, single-entry bookkeeping can’t give you any real insight into your business’s performance.

A more complex double entry bookkeeping example

Note that these records would also have a date, but we are just going to omit it for now. By tracking all entries in two accounts, double-entry bookkeeping also lets you spot and resolve any mistakes quickly and with accuracy. You’ll also be able to identify the profitable aspects of your business, and the ones that are less so. Understanding these misconceptions can help demystify double-entry accounting and highlight the benefits for accurate financial recording, reporting, and analysis. It’s a valuable tool that can provide structure and reliability in managing both business and personal finances.

Procurement / Purchase Department

A bookkeeper reviews source documents—like receipts, invoices, and bank statements—and uses those documents to post accounting transactions. If a business ships a product to a customer, for example, the bookkeeper will use the customer invoice to record revenue for the sale and to post an accounts receivable entry for the amount owed. Double-entry accounting is the standardized method of recording every financial transaction in two different accounts. For each credit entered into a ledger there must also be a corresponding (and equal) debit. Double-entry bookkeeping is an important concept that drives every accounting transaction in a company’s financial reporting. Business owners must understand this concept to manage their accounting process and to analyze financial results.

Example 2: Buying raw materials on supplier credit

Alongside your income statement and cash flow statement, it gives you, your accountant, and your financial investors a well-rounded snapshot of your business’s financial health. But if you’re dealing with a larger client base and have multiple expenses and invoices a month, we strongly recommend using double-entry accounting instead. Debit and credit have slightly different meanings when we’re talking about bookkeeping instead of banking. In accounting terms, a debit marks an increase in assets (or total value) and a decrease in liability (or money you owe), and a credit marks a decrease in assets and an increase in liabilities.

What Is the Difference Between Single-Entry Accounting and Double-Entry Accounting?

What causes confusion is the difference between the balance sheet equation and the fact that debits must equal credits. Keep in mind that every account, whether it’s an asset, liability, or equity, will have both debit and credit entries. Double-entry bookkeeping is an accounting method where each transaction is recorded in 2 or more accounts using debits and credits. A debit is made in at least one account and a credit is made in at least one other account.

For instance, if a business takes a loan from a financial entity like a bank, the borrowed money will raise the company’s assets and the loan liability will also rise by an equivalent amount. If a business buys raw materials by paying cash, it will lead to an increase in the inventory (asset) while reducing cash capital (another asset). Because there are two or more accounts affected by every transaction carried out by a company, the accounting system is referred to as double-entry accounting. Post-Pacioli’s treatise, the 16th and 17th centuries saw this revolutionary bookkeeping method spread across Europe. Merchants and traders rapidly adopted it to keep an accurate and reliable record of their financial transactions, providing them a clear financial snapshot of their businesses. The method enabled them to track their assets, liabilities, and equity – allowing them to gauge their financial standing and make informed business decisions.