Double Entry Bookkeeping – What is it and the importance of it?
In accounting, a double-entry bookkeeping system is a method wherein every transaction is recorded twice. Once on the debit side and the other on the credit side. The main reason to follow this format is to increase the accuracy in accounting and bookkeeping and it also helps in reducing error.
For example, if Ajay Stationery takes a loan of Rs. 5,00,000 the accounting would be recorded in cash, so assets are credited with the cash. At the same time, it would also be recorded in liabilities. This is because the cash increases by Rs. 5,00,000 and the liabilities also increase by Rs. 5,00,000 due to it being a loan.
While no one knows the actual origin of the double-entry bookkeeping, some historical research papers show this system being used since the 1400s. Easy to say the double-entry bookkeeping is one of the most trusted and efficient ways of accounting.
While this format can be done manually with a simple tally software and an accountant, with the ease of technology and cloud accounting, we provide you with a double-entry bookkeeping software that is easy to use and extremely reliant on.
Double Entry Bookkeeping Accounting Equation
As mentioned above, this bookkeeping format is where a single transaction is recorded in more than one account. One is on the debit side and the other being on the credit side.
If a transaction of value Rs. 10,000 has occurred, the transaction needs to be recorded on the debit and credit side. The total amount of the transactions in each case must balance out, ensuring that all money value is accounted for.
The value of Debit = The value of Credit
The above statement holds true because of the accounting formula
Assets = Liabilities + Equity
Thus, Debit Accounts which are assets = Credit Accounts which are liabilities and equities
Most often than not, debit accounts are usually on the left-hand side of the ledger, and credit accounts are on the right-hand side of the ledger.
Who uses the double-entry bookkeeping system?
Most corporate firms, offices, public companies, small companies, law firms, limited partnerships use the double-entry bookkeeping system. The advantages of uses this type of accounting system outweigh the disadvantages of using it.
So, even though you are a small business or think you do not need this type of accounting format, be open to adopting it and switching the format for your accounting. Since this system has been used for centuries and is adopted worldwide it sure has benefits that will have an impact on your business.
No matter the nature and business of your firm, you can always find software that caters to your need for, the double-entry bookkeeping system.
How to do double-entry bookkeeping?
Back in the days, when technology had not evolved so much, businesses and accountants would manually enter the transaction in ledgers in their registers or paper files. After the evolution of computers and software, businesses moved to Tally which was the sole accounting software.
But with the latest evolution being in cloud accounting, you can now have your accounts done on double-entry bookkeeping software. The software lets a business create custom accounts, like an “employee expense” account to record purchases of travelling cost of employees, train or bus pass, any work-related trip, insurance, etc. You can also connect your business bank account to make recording transactions easier.
Accounting software will generate business reports for your firm, list down the expenses in different categories, and give you an overview of the accounting of your firm. Making your tax ready for when tax filing season arrives.
The concept of double-entry bookkeeping
When you use the double-entry bookkeeping system, there are a few accounts that you come across while recording the transactions. Some of the most common accounts that you will encounter are:
- Asset Accounts – These are the transactions that will increase the net worth of the company and are hence known as asset accounts. Some of them are Cash and cash securities, land, and factory, etc.
- Liability Accounts – These are the transactions that will decrease the net worth of the company or the money that the company owes. These could be transactions such as loans, credit balances, etc.
- Income Accounts – The accounts from where the cash flow of the company comes in, such as sales revenue, interest earned, dividend, etc.
- Expense Account – The expenses that the company has to incur for the running of the business. Examples of these are the cost of goods, salary expense, rent paid, electricity and water bill, etc.
There are also 3 major concepts of double-entry bookkeeping:
- All transactions must be recorded at least twice.
- For every transaction recorded, the debit must always equal the credit.
- A = L + E i.e. Assets must always be equal to the liabilities and equities.
Rules of double-entry bookkeeping
Every account has two “sides”, a right side and a left side as mentioned above. Most of the time, a debit transaction refers to an entry on the left side of an accounting ledger, and a credit transaction refers to an entry on the right side of an accounting ledger.
Double-entry bookkeeping requires that for every transaction, there is an entry to the left side of one (or more) account, and a corresponding entry to the right side of another account(s). Sometimes, an entry is recorded more than twice due to certain rules and exceptions.
Some of the common rules of double-entry bookkeeping are:
– Expenses are always debits
– Revenues are always credits
– Debit the cash account when cash is received
– Credit the cash account when cash is paid out
One common saying to remember when doing your accounts:
Debit what comes in and credit what goes out
Importance of double-entry bookkeeping
The importance of double-entry bookkeeping are plenty and a business only has more to gain from this accounting system.
The importance of this accounting format is that it includes the ability to compare financial activity in a meaningful way between periods, such as month-to-month or year-to-year. This leads to reliable financial information upon which accurate financial reports can be based.
Double-entry accounting helps guarantee accurate financial records by revealing data entry errors and it provides a complete record of financial transactions for a business.
Another importance is that double-entry bookkeeping has over single-entry bookkeeping are that the owner can accurately calculate profit and loss in complex organizations, financial statements can be prepared directly from the books, and frauds are easy to detect. Double-entry is also the common language of accountants, so financial records in this format may make your accountant’s job easier and more affordable. Increasing the efficiency and productivity of your firm!