The Double Entry Accounting System

The double-entry accounting method has many advantages over the single-entry accounting method. First and foremost, it provides an organization with a complete understanding of its financial profile by noting how a transaction affects both credit and debit accounts. It also makes spotting errors easier, because if debits and credits do not match, then something is wrong. The basic double-entry accounting structure comes with accounting software packages for businesses. When setting up the software, a company would configure its generic chart of accounts to reflect the actual accounts already in use by the business. The double-entry system requires a chart of accounts, which consists of all of the balance sheet and income statement accounts in which accountants make entries.

How do debits and credits work with double-entry accounting?

To account for the credit purchase, a credit entry of $250,000 will be made to accounts payable. The debit entry increases the asset balance and the credit entry increases the notes payable liability balance by the same amount. In the double-entry accounting system, transactions are recorded in terms of debits and credits. Since a debit in one account offsets a credit in another, the sum of all debits must equal the sum of all credits. Another example might be the purchase of a new computer for $1,000. You would need to enter a $1,000 debit to increase your income statement «Technology» expense account and a $1,000 credit to decrease your balance sheet «Cash» account.

Additionally, the nature of the account structure makes it easier to trace back through entries to find out where an error originated. As a company’s business grows, the likelihood of clerical errors increases. Although double-entry accounting does not prevent errors entirely, it limits the effect any errors amended tax return have on the overall accounts.

Who invented double-entry accounting?

Since all accounts affected are journalized, the records would be «complete», making it is easier to determine account balances (more on this later). The double entry accounting system emerged as a result of the industrial revolution. Merchants in the olden times recorded transactions in simple lists, similar to what we call today as single entry method. Through the ages, businesses expanded and finance became more and more complex, hence, the development of more effective ways to track business transactions.

Double-entry accounting in action

To account for the credit purchase, entries must be made in their respective accounting ledgers. Because the business has accumulated more assets, a debit to the asset 5 reasons for quality inventory management systems account for the cost of the purchase ($250,000) will be made. Many companies, regardless of their size or industry, use double-entry accounting for their bookkeeping needs because it provides a more accurate depiction of their financial health. This bookkeeping method also complies with the US generally accepted accounting principles (GAAP), the official practice and rules for double-entry accounting.

When you receive the $780 worth of inventory for your business, your inventory increase by $780, and your account payable also increases by $780. The double-entry system began to propagate for practice in Italian merchant cities during the 14th century. Before this there may have been systems of accounting records on multiple books which, however, did not yet have the formal and methodical rigor necessary to control the business economy.

In the double-entry accounting system, at least two accounting entries are required to record each financial transaction. These entries may occur in asset, liability, equity, expense, or revenue accounts. If the accounting entries are recorded without error, the aggregate balance of all accounts having Debit balances will be equal to the aggregate balance of all accounts having Credit balances. Regardless of which accounts and how many are involved by a given transaction, the fundamental accounting equation of assets equal liabilities plus equity will hold. This is a partial check that each and every transaction has been correctly recorded. The transaction is recorded as a «debit entry» (Dr) in one account, and a «credit entry» (Cr) in a second account.

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

To increase the balance in a liability or stockholders’ equity account, you put more on the right side of the account. In accounting jargon, you credit the liability or the equity account. To decrease a liability or equity, you debit the account, that is, you enter the amount on the left side of the account. The primary disadvantage of the double-entry accounting system is that it is more complex. It requires two entries to be recorded when one transaction takes place.

1. From these nominal ledger accounts, a trial balance can be created.
2. A commonly used report, called the «trial balance,» lists every account in the general ledger that has any activity.
3. You can hire an accountant and bookkeeper to do your business’s double-entry bookkeeping.

Double Entry: What It Means in Accounting and How It’s Used

Did the first sample transaction follow the double-entry system and affect two or more accounts? Joe looks at the balance sheet again and answers yes, both Cash and Common Stock were affected by the transaction. You can hire an accountant and bookkeeper to do your business’s double-entry bookkeeping. Or, FreshBooks has a simple accounting solution for small business owners with no accounting background. Double-entry bookkeeping produces reports that allow investors, banks, and potential buyers to get an accurate and full picture of the financial health of your business. Let’s look at some examples of how double-entry bookkeeping is used for some common accounting transactions.

However, the chart of accounts will not include any transaction amounts or account balances. The third financial statement that Joe needs to understand is the Statement of Cash Flows. This statement shows how Direct Delivery’s cash amount has changed during the time interval shown in the heading of the statement.

Marilyn points back to the basic accounting equation and tells Joe that if he memorizes this simple equation, it will be easier to understand the debits and credits. The double entry is based on the debit and credit accounts of the transaction. So, we need to understand what account kind of debits and what credits.

Double entry accounting is based on a simple principle, that for every debit, must have equal and opposite credit. You invested $15,000 of your personal money to start your catering business. When you deposit $15,000 into your checking account, your cash increases by $15,000, and your equity increases by $15,000.

The total amount credited has to equal the total amount debited, and vice versa. Recording multiple transactions that require both credit and debit entries can be time-consuming and lead to mistakes. It is recommended to use an accountant for your business or accounting software to ensure that all transactions are recorded correctly. Each entry has a “debit” side and a “credit” side, recorded in the general ledger. Conversely, liabilities and equity increase when credited and decrease when debited. The asset account «Equipment» increases by $1,000 (the cost of the new equipment), while the liability account «Accounts Payable» decreases by $1,000 (the amount owed to the supplier).

This content has been made available for informational purposes only. Learners are advised to conduct additional research to ensure that courses and other credentials pursued meet their personal, professional, and financial goals. Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.