What Is Double-Entry Bookkeeping? An In-Depth Look at One of the Pillars of Accounting
Double-entry bookkeeping – as the name implies – means that every business transaction is entered twice in the accounting records.
Wait, why twice?
Entering everything twice sounds like a lot more work, but the real benefit of this system is that business owners have a complete picture of the financial performance of their businesses when they use double-entry bookkeeping.
Let me explain.
What Is Double-Entry Bookkeeping?
With the double-entry bookkeeping method, every financial transaction in a business is entered in at least two different accounts. Accounts are used to track what a company uses its financial resources for, what those resources are, and where they came from. For example, when a customer buys something and pays with cash, that transaction will be recorded in the sales and cash accounts. This makes it possible to distinguish cash received from sales to customers from the cash received as a loan from a bank.
Italian merchants first devised the double-entry bookkeeping system to overcome the shortcomings of single-entry bookkeeping, which only tracks the money coming in and going out. By adding a mirror image of each transaction, those merchants discovered they could easily track the amount of cash they had and where the cash came from, who owed them money, whom they owed money to, and what they spent their money on. This centuries-old method, which was first documented in a book by Luca Pacioli in 1494, is still used as the foundation of all double-entry accounting methods used for financial reporting.
Fun fact: I have a painting of Luca Pacioli on my wall in the FloQast office. I’m a nerd.
How Do You Record a Double Entry?
Double-entry accounting is recorded using journal entries. The first step to recording transactions using the double-entry accounting system is to determine which two (or more) accounts are impacted by a particular business transaction, the transaction amount, and the date on which the transaction takes place.
Let’s say that on January 15, the owner of Betsy’s Widgets spent $45.97 on office supplies. In this simple example, the Cash account will be decreased by $45.97 while Office Supplies will increase by that same amount – $45.97 – and the transaction will be dated January 15.
Journal entries are recorded in the general ledger, the core of an organization’s system of bookkeeping. The general ledger sorts transactions according to a chart of accounts, listing all of the accounts that a business needs to track. Examples of commonly used accounts are Cash, Sales, Accounts Receivable, Accounts Payable, Payroll, and Owner’s Equity.
Each account is assigned to a particular section of the financial statements. Cash and Accounts Receivable are asset accounts and show up on the balance sheet. Accounts payable is a liability account and shows up on the balance sheet. Sales and Payroll are reported on the income statement.
What is the Matching or Dual Aspect Principle?
The dual aspect principle states that every transaction in an organization’s accounting system must be entered as a combination of debits and credits across at least two accounts. The total debits and total credits in every transaction must match. The idea behind the dual aspect principle is summarized in the accounting equation:
Assets = Liabilities + Owner’s Equity
The accounting equation also defines the balance sheet. At any point in time, an organization’s assets must be equal to the sum of its liabilities plus the owner’s equity. Net income flows from the income statement to accumulate in the owner’s equity.
Applying the dual aspect principle to our simple example above, purchasing office supplies reduced cash by $45.97. Since cash is an asset account on the left side of the equation, the right side of the equation must also decrease by the same amount. Adding $45.97 to the expense account, Office Supplies reduces net income and thus owner’s equity to keep everything in balance.
The Rule for Debits and Credits
The matching principle of bookkeeping says that debits must equal credits. By convention, transactions that increase the left side of this equation are recorded as debits, and transactions that increase the right side are recorded as credits.
The matching rule for debits and credits and the accounting equation means that a debit entry or a credit entry has on the balance in a particular account depending on that account’s classification in the financial statements. Asset accounts are increased by debits, while credits increase liability and equity accounts. Over on the income statement, revenue is increased by credits while debits increase expense accounts.
Keeping debits and credits and their impact on account balances straight can be confusing, so the chart below lists the different types of accounts and their normal balances.
|Account Type||Normal balance|
Using this chart, it’s easy to see that asset accounts typically have a debit balance, so a credit entry will decrease the balance, while a debit entry will increase the balance. The reverse holds true for credit accounts such as liabilities: Credits increase credit balances, and debits decrease those balances.
Why is Double-Entry Bookkeeping Important?
Single-entry accounting is how you track the running balance in your checking account. While keeping an eye on your online bank balance is useful for monitoring your cash flow, that won’t give you much information about what you’re spending money on in your business, or where it’s coming from. Double-entry accounting does that by tying together all the accounts impacted by a particular event in your financials to deliver a complete picture of business performance.
At any point, all transactions in the general ledger can be summarized as the trial balance, which shows the cumulative balances of debits and credits in each account. If every entry has been recorded correctly, debits will equal credits, and the accounting equation will balance. The trial balance forms the basis of financial accounting.
Further sorting and aggregating accounts and their balances creates financial statements, which must follow accounting principles, a set of rules and guidelines that standardize the reporting of business transactions. At a glance, your financial statements will tell you if your business is making a profit, and whether your assets are greater than your liabilities. You can see the flow of resources through your business and you have a foundation for making business decisions.
Real-World Example of Double Entry
Let’s walk through a couple of examples of transactions and their journal entries to see how this works. Betsy’s Widgets sells 25 widgets to Tools R Us. Tools R Us promises to pay on delivery. Betsy’s Widgets bought those widgets for $80 a piece and sold them for $100.
First, to record the sale, Sales and Accounts Receivable are both increased by the amount of the sale (25 x $100 = $2500):
Betsy’s Widgets pulls those widgets from inventory for shipment to Tools R Us. Cost of Goods Sold is increased by the cost of the widgets, and inventory is decreased by the same amount (25 x $80 = $2000):
|Cost of Goods Sold||$2000|
On delivery, Tools R Us pays the invoice, so Cash is increased by $2500 while Accounts Receivable drops by the same amount:
Using Accounting Software for Double-Entry Bookkeeping
Until accountants got computers, double-entry accounting was done with paper ledgers and pens — a laborious and error-prone process. While some small business owners use spreadsheets for their double-entry accounting system, most people use accounting software for their bookkeeping. With accounting software, much of the process of matching debits and credits and choosing the correct accounts happens behind the scenes – and with fewer mistakes.
Accounting software adheres to the same principles of double-entry bookkeeping. Each transaction is recorded in two or more accounts, with debits equaling credits. When you import a bank feed into your accounting software, you’ve already got one side of each entry – the impact on that cash or credit card account. Then, depending on how your system operates, you may need to fill in the other side of each transaction or match the information from your bank to the transactions in your software to reconcile your cash account to the bank statement.
Sooner than we may imagine, advances in AI, automation, and accounting technology will be performing the entire accounting process with little need for human intervention. (Sidebar: No, technology isn’t going to take your job. Check out this handy blog by former auditor, accountant, and current FloQast account executive, Nikko Jones) But having a solid understanding of what’s happening behind the scenes is essential for identifying problems in the processing of transactions and understanding the flow of resources through your business and the data flowing through your accounting records.