What Is Double Entry?
Double entry, a fundamental concept underlying present-day bookkeeping and accounting, states that every financial transaction has equal and opposite effects in at least two different accounts. It is used to satisfy the accounting equation:
The Basics of Double Entry
In the double-entry 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. The double-entry system of bookkeeping or accounting makes it easier to prepare accurate financial statements and detect errors.
Types of Accounts
Bookkeeping and accounting are ways of measuring, recording, and communicating a firm's financial information. A business transaction is an economic event that is recorded for accounting/bookkeeping purposes. In general terms, it is a business interaction between economic entities, such as customers and businesses or vendors and businesses.
Under the systematic process of accounting, these interactions are generally classified into accounts. There are seven different types of accounts that all business transactions can be classified:
Bookkeeping and accounting track changes in each account as a company continues operations.
Debits and Credits
Debits and credits are essential to the double entry system. In accounting, a debit refers to an entry on the left side of an account ledger, and credit refers to an entry on the right side of an account ledger. To be in balance, the total of debits and credits for a transaction must be equal. Debits do not always equate to increases and credits do not always equate to decreases.
A debit may increase one account while decreasing another. For example, a debit increases asset accounts but decreases liability and equity accounts, which supports the general accounting equation of Assets = Liabilities + Equity. On the income statement, debits increase the balances in expense and loss accounts, while credits decrease their balances. Debits decrease revenue and gains account balances, while credits increase their balances.
The Double-Entry Accounting System
Double-entry bookkeeping was developed in the mercantile period of Europe to help rationalize commercial transactions and make trade more efficient. It also helped merchants and bankers understand their costs and profits. Some thinkers have argued that double-entry accounting was a key calculative technology responsible for the birth of capitalism.
The accounting equation forms the foundation of the double-entry accounting and is a concise representation of a concept that expands into the complex, expanded and multi-item display of the balance sheet. The balance sheet is based on the double-entry accounting system where total assets of a company are equal to the total of liabilities and shareholder equity.
Essentially, the representation equates all uses of capital (assets) to all sources of capital (where debt capital leads to liabilities and equity capital leads to shareholders' equity). For a company keeping accurate accounts, every single business transaction will be represented in at least of its two accounts.
For instance, if a business takes a loan from a financial entity like a bank, the borrowed money will raise the company's assets and the loan liability will also rise by an equivalent amount. If a business buys raw material by paying cash, it will lead to an increase in the inventory (asset) while reducing cash capital (another asset). Because there are two or more accounts affected by every transaction carried out by a company, the accounting system is referred to as double-entry accounting.
This practice ensures that the accounting equation always remains balanced – that is, the left side value of the equation will always match with the right side value.
- Double-entry refers to an accounting concept whereby assets = liabilities + owners' equity.
- In the double-entry system, transactions are recorded in terms of debits and credits.
- Double-entry bookkeeping was developed in the mercantile period of Europe to help rationalize commercial transactions and make trade more efficient.
- The emergence of double-entry has been linked to the birth of capitalism.
Real World Example of Double Entry
A bakery purchases a fleet of refrigerated delivery trucks on credit; the total credit purchase was $250,000. The new set of trucks will be used in business operations and will not be sold for at least 10 years—their estimated useful life.
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 account for the cost of the purchase ($250,000) will be made. To account for the credit purchase, a credit entry of $250,000 will be made to notes payable. The debit entry increases the asset balance and the credit entry increases the notes payable liability balance by the same amount.
Double entries can also occur within the same class. If the bakery's purchase was made with cash, a credit would be made to cash and a debit to asset, still resulting in a balance.