What is Double-Entry Accounting?
Double Entry Accounting System is an accounting approach under which each and every accounting transaction requires a corresponding and opposite entry in the accounting records and the number of transactions entered as the debits should be equal to that of the credits.
This accounting system is prevalent in majorly all countries across the globe that follow a systematic pattern of maintaining transaction entries in the system. It refers that any entry made to the system will affect at least two accounts. One of the accounts needs to be a part of Assets, and the other will be under Liabilities. Hence, the effect is precisely equal and opposite.
Consider that if a person purchases something, say a handbag, there will be one transaction where he pays the amount for the bag. Now, as per the double-entry accounting system, another corresponding transaction should be created, which should be receipt of the handbag so that there is a net effect.
Once again, if a company offers a service, say car cleaning services, one transaction should be the amount it receives for the services rendered, which is the actual transaction made in terms of money. However, as per the double-entry system of accounting, one more transaction needs to be recorded – the reason why the company received the amount. Hence, it is recorded as Services Revenue A/c.
Double Entry Accounting Examples
Annie purchased a laptop worth $5,000. She paid cash for the same from all the savings she had made for this. Hence, the entries for this date should be:
Dan booked an office table for his new set up at $2,000. He paid $1,000 in advance, and $1,000 was due upon delivery after the table was ready. Here is how the entries should be posted in the Double entry system of accounting on that particular date:
The first case is a clear example of a debit and a corresponding credit – the net amount is 0. In the second case, although three accounts were given effect, the net entry between debit and credit is “0”. Hence, the double-entry system of accounting suggests that every debit should have a corresponding credit, whether the transaction realizes or not, to get nullified. On the date when Dan booked his office table, he paid only $1,000. Even if the rest of the amount is not paid on this day, it becomes accrued in Accounts Payable A/c (which means it is supposed to be paid on a later date).
Once the amount is paid after the delivery of the table, below will be the effect of entries:
ABC Corporation provides laptop repair services. They offer services on the advance part-payment policy. A customer walked into their shop for services, paid $500 in the beginning, and once the laptop got repaired, he paid $500 upon delivery. In this case, entries on the first day will be as follows:
On the date of delivery, below will be the entries in the company’s system:
If we take a net effect for both these days only in the company’s accounting system, we see that Cash A/c holds $1,000 debit, and Service Revenue holds $1,000 credit, which again nets off the total amount.
Requirements For Double Entry Accounting System
This Double entry system of accounting requires that the total amount of all assets should always be equal to the total amount of all liabilities at any given point in time. Thus, the balance sheet, which maintains the records of all assets on one side, and all liabilities (and shareholders’ equity) on the other, should always have a matching figure, failing which will denote that some entry got missed or incorrectly entered from the ledger.
In other words, the key principle of the double-entry system of accounting can also be written this accounting equation as:
Accounting of transactions into the books is a very complicated system. There is numerous chart of accounts which may be specific for different industries, and /or the transactions may be reported in unique ways by each individual who may get confusing for the other person. If not properly maintained, it creates ambiguity for the entire economy. This is one of the main reasons why the double-entry system of accounting is put in place.
- The double entry system of accounting brings standardization across all the industries and companies which use it.
- It is helpful in the overall reporting structure.
- Company analysis gets simpler since anyone can decode the parameters and entries.
- It is easy to understand and predictable. With each entry, the double-entry system of accounting becomes easy to identify what type of transaction must have taken place.
- The auditing task made simpler.
- All similar type of chart of accounts can be put together, and thus creating a balance sheet or profit and loss statement can be made more accessible.
- If the assets and liabilities (or total debit and total credit) entries do not match, mistakes can be easily determined, and with the existence of proper chart of accounts and ledger, missing or incorrect entries can be sorted out.
On the other hand, had the accounting terms and entries been using different mode (say a single entry system), or if it were not standardized, below would have been the troubles faced:
- Individual accounting terms and entries may create a massive list of the chart of accounts. Tallying and comparing with those used by others for further analysis would have been cumbersome and time-consuming (plus waste of effort).
- It creates confusion, and the possibility of multiple entries, thus creating an incorrect balance.
- The equality between assets and liabilities (or debit and credit) serves as a check for matching all types of transactions. Had this check not existed, the troubles in the system of accounting can be estimated.
This System forms a strong pillar for the modern-day accounting system.
Double Entry Accounting System Video
This article has been a guide to what is Double Entry Accounting system and its definition. Here we discuss double-entry accounting examples, requirements of such a system, and its advantages and disadvantages. You may also learn more about basic accounting from the following recommended articles –