With double-entry bookkeeping, each transaction is documented using debits and credits in two or more accounts. There is at least one debit from one account and at least one credit from another. Total debits and credits must equal zero (equal each other)..
For instance, a copywriter spends $1,000 on a brand-new laptop for her company. She debits her cash account by $1,000 and credits her technological expense account by the same amount. This is because she has $1,000 less in cash and $1,000 more in technology expense assets.
What Are The Rules Of Double-Entry Bookkeeping?
The double-entry method in bookkeeping consists of three main components, namely:
- Every business transaction or accounting entry must be recorded using at least two accounts in the books.
- The total amount of debits and credits reported for each transaction must be equal.
- An organization's total assets must always be equal to the sum of its liabilities and equity (net worth or capital). Both sides of this equation must be balanced and equal.
The Accounting Equation
When we examine the accounting equation, one of the core ideas in accounting, the aforementioned is made more evident. This equation must have the same values on both sides. If they aren't, the books contain an error.
Assets = Liabilities + Equity
In order for the equation to be balanced, if assets increase, liabilities must also increase.
As an illustration, an online retailer purchases $1,000 worth of products on credit. Liabilities (accounts payable) rise by $1,000 while assets (the inventory account) rise by $1,000.
Therefore, the accounting equation's two sides are equivalent. Debiting inventory and crediting accounts due in the books reflects this.
What Are The Different Types Of Accounts?
In double-entry accounting, there are 5 types of accounts that must always be used:
- Asset accounts keep track of the monetary value of the things a company possesses, including cash in its bank account, machinery, and real estate.
- Liability accounts keep track of how much a company owes on things like credit lines or mortgages.
- The difference between assets and liabilities is called equity (also known as the book value of the business)
- Income accounts, like revenue, serve to record money received.
- Expense accounts keep track of your expenditures on things like payroll and advertising.
Your chart of accounts is made up of these 5 categories of accounts. The chart of accounts, which is used to produce financial statements, is a different category group for the financial transactions in your firm.
Advantages Of Double-Entry Bookkeeping
- The accuracy of the records is confirmed when the credit and debit sides add up.
- Accounting experts are quick to spot mistakes and correct them if there is a discrepancy in the data.
- The record-keeping guidelines for all financial institutions and businesses are established under this accounting system.
- The records continue to be organized because of the special reporting structure.
- It is simpler to generate a balance sheet because all related information is gathered together.
- The financial responsibilities are simpler to recognise because the liabilities are clearly stated.
- Making financial decisions is simpler when the whole financial picture is crystal clear because decision-makers are well-informed.
- Double-entry accounting follows the principle that an organization's assets are equal to its liabilities plus its owners' equity.
- Transactions are recorded using a debits and credits approach.
- During the European mercantile age, double-entry accounting was created to help streamline business operations and boost trade effectiveness.
- Double-development entry has been connected to the beginning of capitalism.