What Is Double-Entry Bookkeeping? A Simple Guide for Small ...

Double-entry bookkeeping is an accounting method where each transaction is recorded in 2 or more accounts using debits and credits. A debit is made in at least ... Skiptocontent × FreshBooks OfficialApp Free-GooglePlay Getit AllArticles Accounting Taxes Startup Estimates Productivity Expenses Other Leadership Reports Invoicing Payments Marketing Insurance ProjectsManagement Finance ResourcesforYourGrowingBusiness SIGNMEUP Articles AllArticles Accounting Taxes Startup Estimates Productivity Expenses Other Leadership Reports Invoicing Payments Marketing Insurance ProjectsManagement Finance ResourcesforYourGrowingBusiness SIGNMEUP 9Min.Read WhatIsDouble-EntryBookkeeping?ASimpleGuideforSmallBusinesses Hub Accounting WhatIsDouble-EntryBookkeeping?ASimpleGuideforSmallBusinesses July14,2022 Double-entrybookkeepingisanaccountingsystemwhereeverytransactionisrecordedintwoaccounts:adebittooneaccountandacredittoanother.Forexample,ifabusinesstakesouta$5,000loan,thecash(asset)accountisdebitedto$5,000andtheoutstandingdebt(liability)accountiscredited$5000.Thismeanscashandoutstandingdebtarenowincreasedbythesameamount. Inthisarticle,we’llcover: WhatIsDoubleEntryBookkeeping? NOTE:FreshBooksSupportteammembersarenotcertifiedincometaxoraccountingprofessionalsandcannotprovideadviceintheseareas,outsideofsupportingquestionsaboutFreshBooks.Ifyouneedincometaxadvicepleasecontactanaccountant. WhatIsDouble-EntryBookkeeping? Double-entrybookkeepingisanaccountingmethodwhereeachtransactionisrecordedin2ormoreaccountsusingdebitsandcredits.Adebitismadeinatleastoneaccountandacreditismadeinatleastoneotheraccount.Thetotaldebitsandcreditsmustbalance(equaleachother). Forexample,acopywriterbuysanewlaptopcomputerforherbusinessfor$1,000.Shecreditshertechnologyexpenseaccountfor$1,000anddebitshercashaccountfor$1,000.Thisisbecausehertechnologyexpenseassetsarenowworth$1000moreandshehas$1000lessincash. WhoUsestheDouble-EntrySystem? ForbusinessesintheUnitedStates,theFinancialAccountingStandardsBoard(FASB),isanon-governmentalbody.Theydecideonthegenerallyacceptedaccountingprinciples(GAAP),whicharetheofficialrulesandmethodsfordouble-entrybookkeeping.  TheInternationalAccountingStandardsBoard(IASB)isanon-governmentalbodythatsetstheInternationalFinancialReportingStandards(IFRS)forofficialaccountingrulesandmethodsusedoutsideoftheUnitedStates.  Publiccompaniesmustusethedouble-entrybookkeepingsystemandfollowanyrulesandmethodsoutlinedbyGAAPorIFRS(thedifferencesbetweenthetwostandardsareoutlinedinthisarticle).  Smallbusinesseswithmorethanoneemployeeorlookingtoapplyforaloanshouldusedouble-entryaccounting.Thissystemisamoreaccurateandcompletewaytokeeptrackofthecompany’sfinancialhealthandhowfastit’sgrowing. Peoplealsoask: WhatAretheRulesofDouble-EntryBookkeeping?WhyIsDouble-EntryBookkeepingImportant? WhatAretheRulesofDouble-EntryBookkeeping? Thereare3majorcomponentstothedouble-entrymethodinbookkeeping.Theyare: Everybusinesstransactionoraccountingentryhastoberecordedinatleasttwoaccountsinthebooks.Foreachtransaction,thetotaldebitsrecordedmustequalthetotalcreditsrecorded. Totalassetsmustalwaysequaltotalliabilitiesplusequity(networthorcapital)ofabusiness.Bothsidesofthisequationmustbethesame(theymustbalance). TheAccountingEquation Theabovebecomesclearerwhenwelookattheaccountingequation,oneofthefundamentalprinciplesofaccounting.Bothsidesofthisequationmustbethesame.Ifthey’renot,there’samistakeinthebooks. Here’stheequation:Assets=Liabilities+Equity So,ifassetsincrease,liabilitiesmustalsoincreasesothatbothsidesoftheequationbalance. Forexample,ane-commercecompanybuys$1,000worthofinventoryoncredit.Assets(theinventoryaccount)increaseby$1,000andliabilities(accountspayable)increaseby$1,000.  Sobothsidesoftheaccountingequationarethesame.Thisisreflectedinthebooksbydebitinginventoryandcreditingaccountspayable. WhatAretheDifferentTypesofAccounts? Thereare5typesofaccountsthatmustalwaysbeusedindouble-entryaccounting: Assetaccountsrecordthemonetaryvalueofwhatabusinessowns,suchasthemoneyinitscheckingaccount,tools/equipment,andbuildingsLiabilityaccountsrecordtheamountabusinessowesonthingslikelinesofcreditoramortgageEquityisthedifferencebetweenAssetsandLiabilities(alsoknownasthebookvalueofthebusiness)Incomeaccountsrecordmoneycomingin,likerevenueExpenseaccountsrecordwhatyou’vespentmoneyon,suchaspayrollandadvertising The5typesofaccountsmakeupyourchartofaccounts.Thechartofaccountsisadifferentcategorygroupforthefinancialtransactionsinyourbusinessandisusedtogeneratefinancialstatements. WhatareDebitsandCredits? Indouble-entrybookkeeping,debitsandcreditsaretermsusedtodescribethe2sidesofeverytransaction.Debitsareincreasestoanaccount,andcreditsaredecreasestoanaccount.  Whenalltheaccountsinacompany'sbookshavebeenbalanced,theresultisazerobalanceineachaccount.Inotherwords,thedebitsequalthecredits. Debits RecordedontheleftofaledgersheetIncreasetheassetandexpenseaccountsordecreaserevenue,equity,andliabilityaccountsThemonetaryvalueisknownasadebitbalanceExample:Youpaymoneytowardabankloan,whichdebits(decreasesorremovesfrom)theliabilityaccount. Credits Recordedontheleftofaledgersheet Decreaseassetandexpenseaccountsorincreaserevenue,equity,andliabilityaccounts Themonetaryvalueisknownasacreditbalance Example:Youreceivepaymentforaserviceyouprovided,whichcredits(increasesoraddsto)therevenueaccount. Double-EntryBookkeepingExamples Let’slookatsomeexamplesofhowdouble-entrybookkeepingisusedforsomecommonaccountingtransactions. Example1:BusinessPurchasesUsingCredit Youpurchase$780worthofinventoryoncredit.Whenyoumakethepayment,youraccountpayabledecreasesby$780,andyourcashdecreasesby$780. So,inyourgeneralledger,youdebittheaccountpayableaccount(aliabilityaccount)andcreditthecashaccount(anassetaccount). Whenyoureceivethe$780worthofinventoryforyourbusiness,yourinventoryincreaseby$780,andyouraccountpayablealsoincreasesby$780. Inyourledger,youdebittheinventory(asset)accountandcredittheaccountpayable(liability)account. Example2:ReceivingaBusinessLoan Youareapprovedforabusinessloanof$9,500.Whenyoureceivethemoney,yourcashincreasesby$9,500,andyourloanliabilityincreasesby$9,500. Inyourledger,youdebitthecash(asset)accountandcredittheloanpayable(liability)account. Example3:PayingforBusinessExpenses Youpay$20forawebsitedomainforyourbusiness.Whenyoupayforthedomain,youradvertisingexpenseincreasesby$20,andyourcashdecreasesby$20. Inyourledger,youdebittheadvertisingexpenseaccountandcreditthecashaccount. Example4:MakingaCapitalContribution Youinvested$15,000ofyourpersonalmoneytostartyourcateringbusiness.Whenyoudeposit$15,000intoyourcheckingaccount,yourcashincreasesby$15,000,andyourequityincreasesby$15,000. Inyourledger,youdebitthecash(asset)accountandcreditthecapital(equity)account. WhyIsDouble-EntryBookkeepingImportant? Verysmall,newbusinessesmaybeabletomakedowithsingle-entrybookkeeping.Butdouble-entrybookkeepingdeliversmanyadvantages.  Thisarticlecomparessingleanddouble-entrybookkeepingandexplainstheprosandconsofbothsystems. DeliversaCompleteFinancialPicture Smallbusinessescanusedouble-entrybookkeepingasawaytomonitorthefinancialhealthofacompanyandtherateatwhichit’sgrowing.Thisbookkeepingsystemensuresthatthereisarecordofeveryfinancialtransaction,whichhelpstopreventfraudandembezzlement. Infact,adouble-entrybookkeepingsystemisessentialtoanycompanywithmorethanoneemployeeorthathasinventory,debts,orseveralaccounts.  Businessesthatmeetanyofthesecriterianeedthecompletefinancialpicturedouble-entrybookkeepingdelivers.Thisisbecausedouble-entryaccountingcangenerateavarietyofcrucialfinancialreportslikeabalancesheetandincomestatement. HelpsCompaniesMakeBetterFinancialDecisions Double-entrybookkeeping’sfinancialstatementstellsmallbusinesseshowprofitabletheyareandhowfinanciallystrongdifferentpartsoftheirbusinessare.Youcanseehowyou’vespentmoneyandhowyourbusinessisdoing.  Thedouble-entryaccountingsystemcanhelpyoumakebetterfinancialdecisionsbyprovidingaccurateandtimelyinformationaboutyourbusiness'sfinancialstatus.  Thisinformationcanbeusedtomakeinformeddecisionsaboutwheretoallocateresources,howmuchdebttotakeon,andwhethertoinvestinnewprojects. ReducesBookkeepingErrors Whenyougenerateabalancesheetindouble-entrybookkeeping,yourliabilitiesandequity(networthor“capital”)mustequalassets.Iftheydon’t,youknowyourbooksarewrong.  Thisfailsafetellsbusinessesiftheirjournalentriesarewrong.Thisaccountingmethodalsomakesiteasiertospoterrorsandcorrectthem.Thedouble-entrysystemisalsoamoretransparentwaytokeepyourbooksandhelpskeepbusinessesaccountable.  PreferredbyInvestors,Banks,andBuyers Becausethedouble-entrysystemismorecompleteandtransparent,anyoneconsideringgivingyourbusinessmoneywillbealotmorelikelytodosoifyouusethissystem. Double-entrybookkeepingproducesreportsthatallowinvestors,banks,andpotentialbuyerstogetanaccurateandfullpictureofthefinancialhealthofyourbusiness. HowIsSingle-EntryBookkeepingDifferent? Single-entrybookkeepingisarecord-keepingsystemwhereeachtransactionisrecordedonlyonce,inasingleaccount.ThissystemissimilartotrackingyourexpensesusingpenandpaperorExcel. Toillustratehowsingle-entryaccountingworks,sayyoupay$1,500toattendaconference.Yourecordthecashgoingoutofyourcheckingaccount.  Thissingle-entrybookkeepingisasimplewayofshowingtheflowofoneaccount.However,itdoesn’ttellyouthefullstoryofyourfinances. Intheexample,becauseyoudidnotrecordtheconferencefeeexpense,itwon’tshowonyourincomestatement(profitandlossstatement).Attaxtime,yourtaxpreparerwon’tbeawarethat$1,500ismissingfromyourexpenses.Youwillhavemissedoutonthedeductionandoverpaidyourtaxes.  HowDoYouStartDouble-EntryBookkeeping? Double-entrybookkeepingisusuallydoneusingaccountingsoftware.Thesoftwareletsabusinesscreatecustomaccounts,likea“technologyexpense”accounttorecordpurchasesofcomputers,printers,cellphones,etc.Youcanalsoconnectyourbusinessbankaccounttomakerecordingtransactionseasier. Accountingsoftwarealsoeasilygeneratesreportswhichmakesgettingreadyfortaxtimeandyear-endmuchsimpler. Youcanhireanaccountantandbookkeepertodoyourbusiness’sdouble-entrybookkeeping.Or,FreshBookshasasimpleaccountingsolutionforsmallbusinessownerswithnoaccountingbackground.Youcandoityourself,whichmakeskeepingthebookseasy. RELATEDARTICLES HowtoCreateaMulti-StepIncomeStatement:AGuidetoIn-DepthFinancialReporting The12BranchesofAccounting:TheirUsesandHowTheyWork WhatIsCostofGoodsSold(COGS)andHowtoCalculateIt WhatIsUnearnedRevenue?ADefinitionandExamplesforSmallBusinesses WhatIstheW-8BEN-EForm?AGuideforNon-USSmallBusinesses AccountingforSalesTax:WhatIsSalesTaxandHowtoAccountforIt SaveTimeBillingandGetPaid2xFasterWithFreshBooks TryFreshBooksFree ContactSales WantMoreHelpfulArticlesAboutRunningaBusiness? GetmoregreatcontentinyourInbox. Bysubscribing,youagreetoreceivecommunicationsfromFreshBooksandacknowledgeandagreetoFreshBook’sPrivacyPolicy.Youcanunsubscribeatanytimebycontactingusathelp@freshbooks.com. 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