Double Entry Accounting is a method of recording transactions where, for every business transaction, an entry is recorded in at least two accounts as a debit or credit. Double-entry accounting is also known as double-entry bookkeeping.
It is a method of accounting that relies on a two-sided entry to maintain financial information. It has two equal and corresponding sides, called debit and credit. The amounts recorded as debits must equal those recorded as credits.
In the Double Entry system, each page is divided into two halves. The left-hand side of each page is called the debit side, while the right-hand side is called the credit side. The title of each account is written across the top of the account at the center.
Typical example of a page of a double entry account book:
Title of account written here
Left hand side of the page Right hand side of the page
(Debit side) (Credit side)
Example, if a business collects a bank loan of $20,000, recording the transaction would require a debit of $20,000 to an asset account called cash and a credit of $20,000 to a liability account called loan payable. The basic entry to record this transaction in a general ledger will be:
Debit Credit
Cash $20,000
Loan payable $20,000
Rules of Double Entry Accounting
The two rules of double-entry accounting are:
- Every transaction must be recorded in two accounts.
- The total amount debited needs to equal the total amount credited.
Steps to Recording Double Entry in Accounting
Step 1: Create a chart of accounts for posting your financial transactions.
Step 2: Enter all transactions using debits and credits.
Step 3: Ensure entry has two components, a debit and a credit entry.
Step 4: Check that financial statements are balanced and reflect the accounting equation.
Debit and Credit
In double-entry accounting, debits and credits are terms used to describe the two sides of every transaction. Depending on the nature of the account, Debit and credit are increased and decreased to an account.
Whether one uses a debit or credit to increase or decrease an account depends on the account’s normal balance. Assets, expenses, and drawings accounts (on the left side of the equation) have a normal debit balance.
Liability, revenue, and capital accounts (on the right side of the equation) have a normal credit balance. On a general ledger, debit is recorded on the left side and credited on the right side for each transaction.
Since the account must always be balanced, for each transaction, there will be a debit made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in each day’s transaction must equal the sum of all credits in those transactions.
When all the accounts in the company’s books have been balanced, the result is a zero balance in each account.
Double-entry accounting is governed by the accounting equation “Assets= liabilities + equity”
Accounting equation is a representation of how assets, liabilities, and capital are associated with each other. Assets represent resources of value owned and controlled by an organisation, for example: machinery and building, while liabilities are its obligations; example, loans and bills. Both liabilities and equity represent how the company’s assets are financed.
The accounting equation helps to assess whether the business transactions carried out by the company are accurately reflected in its books and accounts.
Also, accounting equation serves as an error detection tool in that if, at any point, the sun of debits for all account does not equal the corresponding sum of credits for all accounts, it is an indication of error.
However, satisfying the accounting equation does not always guarantee the absence of errors because the account will still be balanced if, for instance, the wrong account has been debited or credited.
Effect of Debits and credits on Accounts (Assets, Liabilities, Capital, Revenue and Expenses)
Debit and credit affect account balances as follows;
- Debit increases the balance in assets and expense accounts and decreases the balance in liability, revenue, and capital accounts. This implies that assets and expenses accounts have balances; total debit usually exceeds total credit in each debit account.
- Credit increases the balance in the liability account, revenue account, and capital account; and decreases the balance in the assets account and expenses account. This implies that revenue (income, gains) and liability accounts usually have credit balances because total credit usually exceeds total debt.
Double Entry Accounting for Assets, Liabilities and Capital
In accounting each transaction affects two items. To show the full effect of each transaction, accounting must show its effect on each of the two items, be it assets, capital or liabilities.
The need to show this two-fold effect resulted in the double entry, where each transaction is recorded twice, once to show the effect upon one item, and the second entry to show the effect upon the other item.
For a transaction that is an increase or decrease in assets, liabilities or capital, double entry rules for the account are as follows:
Account To Record Entry in the account
Assets An increase Debit
A decrease Credit
Liabilities An increase Credit
A decrease Debit
Capital An increase Credit
A decrease Debit
The double entry rules for liabilities and capital are the same but opposite to those of assets. This is because assets are on the opposite side of the equation and, therefore follow the opposite rule.
Double Entry Accounting for Expenses and Revenue:
In accounting, the decision is made regarding which side of the account revenues and expenses are to be recorded. Like assets, expenses involve expenditure by the form and are therefore also recorded on the debit side of the books.
The difference between assets and expenses is that assets are expenditures of money for which something still remains, while expenses involve expenditures of money that is used up in the running of the business and for which there is no benefit remaining at the date of the statement of financial position.
Revenue is the opposite of expenses and, therefore, appears on the opposite side of expenses, that is., the credit side of the book. Revenue increases profit, which in turn increases capital.
Note: every expense results in a decrease in an asset or an increase in a liability. Expense reduces capital, and a decrease in capital needs a debit entry.
Benefits Of Double Entry Accounting
- Double-entry accounting reduces the likelihood of book-keeping mistakes.
- Provide insight into a company’s profitability.
- Help to track company’s financial growth.
Conclusion
Double Entry accounting is based on balancing the books and satisfying the accounting equation. Although satisfying the equation does not guarantee a lack of error, the account will still balance if, for example, the wrong account is debited or credited. Accounting equation serves as an error detection tool if the sum of debits for all accounts does not equal the corresponding sum of credits for all accounts.
Contributor: offiong.patience@yahoo.com
One Comment