Double entry bookkeeping is the concept that every accounting transaction has two affects on a company’s finances. The general ledger is the record of the two sides of each transaction. If a company sells a product, its revenue increases and its cash increases by an equal amount. When a company borrows funds from a creditor, the cash balance increases, but the balance of the company’s debt increases by the same amount.
The double entry system creates a balance sheet made up of assets, liabilities and equity. The sheet is balanced because a company’s assets will always equal its liabilities plus equity. Assets include all of the items that a company owns, such as inventory, cash, machinery, buildings and even intangible items such as patents. Liabilities represent everything the company owes to someone else, such as short-term accounts payable owned to suppliers or long-term notes payable owed to a bank. Equity represents the owners’ stake in the company. Equity may include any contributions the owners have made to the company, plus the company’s profits or minus the company’s losses.
Each entry has a “debit” side and a “credit” side, recorded in the general ledger. Asset accounts increase when debited and decrease when credited. Conversely, liabilities and equity increase when credited and decrease when debited. If an asset increases with a debit, then the credit side of the entry will either affect another asset by decreasing it, or affect a liability or equity account, increasing it, in order to keep the assets = liabilities + equity equation in balance.
For example, if Lucie opens a new grocery store, she may start the business by contributing some of her own savings of $100,000 to the company. The first entry to the general ledger would be a debit to Cash, increasing the assets of the company, and a credit to Equity, increasing Lucie’s ownership stake in the company. If Lucie purchases some shelving units for $5,000 on the company credit card, the next entry to the general ledger would be a debit to Equipment for $5,000, increasing the assets of the company, and a credit to Credit Card Due for $5,000, increasing the liabilities of the company.
A sub-ledger may be kept for each individual account, which will only represent one half of the entry. The general ledger, however, has the record for both halves of the entry. When Lucie purchases the shelving, the Equipment sub-ledger would only show half of the entry, which is the debit to Equipment for $5,000. The Credit Card Due sub-ledger would include a record of the other half of the entry, a credit for $5,000. The general ledger would have two lines added to it, showing both the debit and credit for $5,000 each.
According to the Wall Street Journal, early use of the double entry system was documented by Luca Pacioli in the 15th century. Accountants in the 1400s used pen and paper for their record keeping, painstakingly keeping track of each double entry. Accountants today do not typically use a physical general ledger book; however, modern accounting software uses the same underlying concept of posting two entries to the general ledger for every transaction.