What is Double Entry Bookkeeping?

Moreover, it’s important to differentiate between a single entry and a double entry accounting system. In a single entry accounting system, transactions only impact one income statement account and one balance sheet account. Single entry accounting systems are common when following the cash basis of accounting, while a double entry bookkeeping system is used in accrual accounting.

How Does Double Entry Bookkeeping Work?

When following a double entry accounting system, transactions are recorded as debits and credits. Debits increase asset balances but decrease liability balances. On the contrary, credits decrease asset balances and increase liability balances. On the income statement, sales and income are credit balances, while all expenses are debit balances.

Let’s say that your accounts receivable balance is $75,000. A customer pays a $5,000 invoice. In this situation, you would credit accounts receivable to lower the balance to $70,000 and debit your cash account by $5,000 to reflect the deposit.

Now, let’s say that your accounts payable balance is $80,000. You decide to pay a $15,000 invoice. As a result, your accounts payable balance will be debited by $15,000, and your cash account will have a credit entry for $15,000.

It’s important to note that these accounting entries follow accrual accounting. If you follow the cash basis of accounting or a single entry bookkeeping system, you would not use payable and receivable accounts. Instead, the transactions would hit cash and your income statement. For example, a $5,000 customer payment would debit your cash balance and credit your sales account.

What is the Accounting Equation?

The accounting equation states that assets must equal liabilities plus equity. If the equation does not balance, there is an error somewhere in your accounting system. This generates the following accounting equation:

Assets = Liabilities + Equity

Let’s say that your asset accounts total $100,000. This means that the sum of your liability and equity accounts must also equal $100,000. After reviewing your balance sheet, you find that your liabilities are $75,000 and your equity is $10,000. Since the sum is only $85,000, you are missing $15,000 of transactions somewhere in your accounting system. This commonly occurs if an unbalanced journal entry is posted.

The Advantages of Double Entry Accounting

The primary advantage of implementing a double entry bookkeeping system is transparency in your transactions. In a single entry system, you aren’t tracking upcoming payments and receivables. Instead, you are only recording transactions when cash is added or removed from your bank account. With double entry accounting, you populate receivable and payable ledgers that help you effectively manage cash flow and develop insights into the financial health of your company.

Additionally, double entry accounting makes it easy to generate financial statements that are compliant with Generally Accepted Accounting Principles and other regulations. These reports can then be used to file tax returns and create detailed financial analyses. Many businesses find that spending the extra time creating a double entry accounting system is beneficial to unlock accurate financial reports, make more informed business decisions, and maximize compliance with regulators.

The Disadvantages of Double Entry Accounting

The main disadvantage of double entry accounting work is that it is more complex. You have to pay close attention to which accounts are debited and credited to maintain the integrity of the accounting equation. In addition, you have to use receivable and payable accounts. Forgetting to record a transaction to the proper business accounts impacts the accuracy of your financial reports.

Furthermore, the complexity of maintaining a double entry accounting system can result in higher professional costs and cause your team to spend more time maintaining your accounting records.

Summary

• Double entry bookkeeping is an accounting method that records transactions using at least two business accounts.
• Double entry accounting systems commonly follow accrual accounting and use payable and receivable accounts on the balance sheet.
• The accounting equation (assets = liabilities + equity) is satisfied in double entry accounting.
• The main advantages of double entry accounting include added transparency, improved cash flow management, boosted accuracy, and compliance with regulators.