What Is Double-Entry Bookkeeping?For starters, let’s break down an in-depth double-entry bookkeeping definition. Double-entry bookkeeping is a bookkeeping method that requires two entries for every transaction, as the name implies. When using the double-entry bookkeeping method, you need to record both a credit and debit for every transaction. A transaction is any activity that has a monetary impact on your business, such as a purchase, sale, payment, or loan. Double-entry bookkeeping is an alternative system to single-entry bookkeeping, which is a one-sided entry. This means that all of the transactions are recorded based on how they affect one account, which is reflected by using positives and negatives. Single-entry bookkeeping does work for some very small businesses, but a major downside is that it does not track each account. While single-entry bookkeeping is slightly quicker, it does not provide a complete picture of the transaction like double-entry bookkeeping does. In order to truly understand how a transaction has impacted your small business’s finances—in regards to your assets, liabilities, and equity—double-entry bookkeeping is preferred and even considered the standard in modern bookkeeping.
Is Bookkeeping Different Than Accounting?You may see the terms double-entry bookkeeping and double-entry accounting used interchangeably. However, accounting and bookkeeping are actually different aspects of your business’s finances that work together. The difference between bookkeeping and accounting is simple:
- Bookkeeping: Bookkeeping is the part of the process that involves recording all of your business’s transactions which is then used to create your financial statements.
- Accounting: Accounting is the part of the process when the financial statements are analyzed and used to draw conclusions about your business’s financial position.
Double-Entry Bookkeeping ExplainedNow that you know what double-entry bookkeeping is on the surface, let’s dive deeper to fully answer “what is double-entry bookkeeping?”
What Are Debits and Credits?First and foremost, we should explain debits and credits because understanding how they work is critical to correct bookkeeping. It is important to note that debits and credits in terms of bookkeeping actually work very differently than what you might expect. While debits are used to reflect that money has been moved into an account, credits reflect when money is moved out of an account. Basically, they are used to denote an increase or decrease in an account. When one account is debited, another must be credited. Let’s take a look at how debits and credits affect different accounts:
- Debits Increase: Asset and expense accounts.
- Debits Decrease: Liability and equity accounts.
- Credits Increase: Liability and equity accounts.
- Credits Decrease: Asset and expense accounts.
The Accounting Equation & Double-Entry BookkeepingDouble-entry bookkeeping is based on balancing the accounting equation, which is as follows:
Assets = Liabilities + EquityThe accounting equation is the “golden rule” of bookkeeping; basically, both sides of the equation must be equal after every transaction. It is also the foundation of the balance sheet, which shows the current position of the company’s assets, liabilities, and equity. To understand how the accounting equation works with the double-entry bookkeeping method, let’s look at how debits and credits reflect changes in each type of account.
- Assets: The assets accounts encompass everything owned by the business, including both tangible and intangible property. An increase in the assets is reflected with a debit, and a decrease is reflected with a credit.
- Liabilities: Liabilities are anything that the company owes. The liabilities accounts are increased by debits and decreased by credits.
- Equity: The equity accounts include everything you have invested in the business, plus profits or minus losses. Equity increases when debited and decreases when credited.
Recording Transactions Using Double-Entry BookkeepingRecording a transaction is known as making a journal entry which is one of the first steps in the accounting cycle . When you’re making a journal entry using double-entry bookkeeping, you need to use T-accounts. This means that all debits should be on the left side and all the credits should be on the right side of the entry for the account. It might sound a little confusing, but in the next section, we will go through examples to demonstrate how you would make a journal entry using double-entry bookkeeping.
Double-Entry Bookkeeping ExamplesNow that we’ve answered “what is double-entry bookkeeping” and have explained how it works, let’s put it into practice with a few real-world examples.
Example 1: Purchase with CashSay that you decide you need to purchase a laptop that you will solely use for business activities (which is highly recommended). If you purchase the new laptop with cash, this is how you would make the journal entry using the double-entry accounting method:
Example 2:A client ordered bulk product from you but has not yet paid for it. You would need to record this transaction as follows:
Benefits of Double-Entry BookkeepingAlthough double-entry bookkeeping requires more time than the single-entry method, it offers many benefits that can significantly impact your business’s finances. The advantages of double-entry bookkeeping include:
- Allows you to check that accounts are balancing
- Contributes to more accurate bookkeeping and financial statements
- Reduces the risk of error
- Enables easy comparison of accounting periods
- Keeps better tabs on your business’s finances in real-time
- Identifies fraud or embezzlement quickly