Bookkeeping is the foundation of accounting and involves systematically recording and classifying a company’s financial transactions. This fundamental concept states that every financial transaction has equal and opposite effects in a minimum of two accounts. Thus, for every corresponding credit to one account, there has to be a debit from another account.
Since its introduction in the mercantile period of Europe, this system has led to the birth of capitalism and the modern world as we know it. Today, the double-entry system is the most widely adopted accounting system accepted globally. It provides the benefit of helping to maintain accurate records of all monetary transactions of a business.
The following sections will cover this fundamental concept of accounting in more detail.
What Is the Double Entry System of Bookkeeping?
In the double-entry system of bookkeeping, every business transaction needs to be recorded in at least two different accounts. This is because every transaction has two parts and affects these accounts with equal and opposite effects. In simpler words, for every credit, there is an equal debit and vice versa. Thus, an accountant needs to enter both for every transaction.
All transactions must satisfy the accounting equation:
Assets = Liabilities + Shareholders’ Equity
The total on both sides of this equation needs to be the same. If total assets and total liabilities plus capital are not equal, there has been a mistake in accounting. If liabilities increase, assets must also be increased to balance the books.
Let us understand the concept of the double entry system with an example. ABC is an e-commerce company that bought Rs. 90,000 worth of inventory on credit. Its assets will increase by Rs. 90,000 in the inventory account, whereas its liabilities as accounts payable will increase by Rs. 90,000.
Transactions are to be first recorded in a journal, then transferred to a T-account or a general ledger. A journal records raw accounting entries for business transactions in a sequential order based on their dates.
A general ledger (GL) is a document that records all past transactions of a company with details such as date, amount, place and description. A T-account is an informal term for financial transactions recorded via the double entry system.
Principles of the Double Entry System of Bookkeeping
In the double-entry system of bookkeeping, every business transaction needs to be recorded in at least two different accounts. This is because every transaction has two parts and affects these accounts with equal and opposite effects. In simpler words, for every credit, there is an equal debit and vice versa. Thus, an accountant needs to enter both for every transaction.
All transactions must satisfy the accounting equation:
Assets = Liabilities + Shareholders’ Equity
The total on both sides of this equation needs to be the same. If total assets and total liabilities plus capital are not equal, there has been a mistake in accounting. If liabilities increase, assets must also be increased to balance the books.
Let us understand the concept of the double entry system with an example. ABC is an e-commerce company that bought Rs. 90,000 worth of inventory on credit. Its assets will increase by Rs. 90,000 in the inventory account, whereas its liabilities as accounts payable will increase by Rs. 90,000.
Transactions are to be first recorded in a journal, then transferred to a T-account or a general ledger. A journal records raw accounting entries for business transactions in a sequential order based on their dates.
A general ledger (GL) is a document that records all past transactions of a company with details such as date, amount, place and description. A T-account is an informal term for financial transactions recorded via the double entry system.
Principles of the Double Entry System of Bookkeeping
The following are some basic principles of the double entry system of bookkeeping:
- In the double entry system, transactions are recorded as credits as well as debits. `
- One needs to write the debit on the left and credit on the right to record entries.
- Every credit entry must have a corresponding debit entry and vice versa, as one of the accounts receives a benefit while the other gives it.
- Under the double entry system, total assets must always be equal to total liabilities and shareholder equity.
Debits refer to any entries recorded for one’s outstanding dues or payments made. Decrease in liability, equity, and income and increase in assets and expenses count as debits. On the other hand, credit refers to entries recorded for payments received. An increase in income, liabilities, equities and decrease in expenses and assets count as credit.
The following examples will illustrate the workings of the double entry system:
A. Let’s say a company takes a loan from a financial institution. Its borrowed money will be added to its assets while its liability (for borrowings) will increase by the same amount.
B. ABC is a company that sold 2 keyboards for Rs. 2000. For this transaction, a debit of Rs. 2000 will happen in its cash account (under Assets) and a credit of Rs. 2000 to sales (under Revenue).
Differences between Single Entry System and Double Entry System
The following are some of the differences between single entry system and double entry system of bookkeeping:
| Basis for Difference | Single Entry System of Bookkeeping | Double Entry System of Bookkeeping |
| Definition | In this bookkeeping system, one records only one part of the transaction. | One needs to enter both the credit and debit sides for every transaction. |
| Taxation | It is not accepted for tax purposes. | This method is acceptable for tax purposes across the world. |
| Adequate System | The single entry system is an inadequate accounting system as it only tracks personal accounts, such as debtors and creditors. | This is a complete bookkeeping system as it records all financial transactions and categorises them into appropriate categories. |
| Usage | Only the business owner can read this as it has no standard format. | All involved parties, including creditors and investors, can read the books due to the standard format. |
| Trial Balance | One cannot prepare a trial balance or financial statement of a company using this. | The double entry system is used for preparing trial balances and financial statements. |
Given are some of the main benefits of using the double entry system:
- Reduces Bookkeeping Errors: Assets and liability plus equity must be equal, or the entries in books and journals are wrong. This ensures accuracy and reduces mistakes in bookkeeping.
- Preferred System for Statutory Bodies, Banks, Investors: Statutory bodies such as the RBI, SEBI and the Registrar of Companies etc., prefer this accounting system. Its transparency also allows banks and investors to get a complete picture of the business’s financial health.
- Helps in Making Better Financial Decisions: It allows companies to maintain accounts in detail, which in turn helps them to make better decisions. Small businesses too can benefit considerably by switching to the double entry system as they can judge their financial performance and spending in more detail.
- Delivers a Detailed Financial Picture: Businesses with large-scale transactions must use a double-entry system as it is necessary to prepare income statements and balance sheets. Small businesses with several employees and accounts may also find the double entry system to be more beneficial.
- Allows Easy Identification of Dues Owed: Businesses can quickly identify what dues they owe to lenders, service providers and suppliers. Making a trial balance quarterly or at the end of the year also ensures accuracy in keeping records of credits and debits.
Final Word
The double entry system of bookkeeping is fundamental for modern-day accounting. It ensures accuracy and gives a clear picture of overall profit and loss. Moreover, businesses can easily identify their dues owed to suppliers and lenders and make fewer mistakes.
This system of bookkeeping has brought along many benefits, including increased transparency and reduced instances of fraud. It also allows for a deep analysis of a company’s financial health.