Bookkeeping services help small businesses grow and stay organised. Tracking every financial transaction makes cash-flow management, profit/loss evaluation, and business decision-making far easier. Various bookkeeping methods exist, but double-entry bookkeeping is the most widely used in business. This article explains how double-entry bookkeeping works and gives practical tips for using it in your company.
Double-entry accounting can help improve the accuracy of a company’s financial records. There are two key terms in accounting: debit and credit. Understanding these terms is essential to using the double-entry bookkeeping system correctly.
But what exactly are debits and credits? What is their significance in the accounting world? Continue reading to see how these essential principles are at the heart of every financial transaction and serve as the foundation of the accounting system.
What is the Double-Entry Bookkeeping System?
Each business transaction is recorded twice in the double-entry bookkeeping system, also known as double-entry accounting. These are called accounting entries, appearing in equal but opposite quantities. The income source of each transaction is in one entry, and the destination of the money is in the other. The double-entry system displays these entries in two columns termed debits and credits.
The two columns must balance, which is a critical element of double-entry. This allows you to track the money that comes into and goes out of your firm. You assure account accuracy through periodic evaluations known as trial balances.
What is the Value of a Double-Entry Bookkeeping System?
A double-entry accounting system is more dependable than a single-entry accounting system, which records purchases and payments as additions or subtractions to a single firm account. Double-entry accounting lets you create additional charges to track money that has not yet been collected (accounts receivable) or paid (accounts payable), as well as products held for sale (inventory).
How Does Double-Entry Mechanism Work?
The accounting equation underpins double-entry bookkeeping: it ensures a business’s accounts balance (debits = credits). It appears as:
Assets = Liabilities + Equity
This equation summarises the balance sheet – one of the three main financial statements (balance sheet, income statement, cash-flow statement). The balance sheet is called so because a company’s assets must equal the financing (liabilities + equity) used to acquire them.
All accounts must be balanced
Accounting personnel can balance business accounts using double-entry bookkeeping. They can accomplish this by ensuring that each transaction recorded into the system has an associated debit and credit. Employers put these transactions into a ledger and categorise them by account type, making it easier for anyone to identify any inaccuracies or missing entries.
Ensuring adequate cash is available
Staff can use double-entry accounting to monitor a company’s financial health to ensure adequate capital is available. Employees can see all the money coming in and out of business using double-entry bookkeeping, making it easier to discover possible errors or concerns with cash flow.
Examining for missing or double-counted transactions
Employees can use double-entry bookkeeping to ensure that no transactions are missed or double-counted by checking to see if both sides of the equation balance. If there is no entry on the revenue side, it signifies that money is missing from the firm because it was not recorded or was counted twice.
Keeping track of liabilities and assets
Keeping track of all the assets and liabilities can be challenging when a company expands quickly. Double-entry bookkeeping is a straightforward and dependable technique for monitoring these items. When a company buys something, it records it as an asset. When they sell something, it becomes a liability. When an employee examines the accounts, they can determine whether the organisation has more assets than liabilities or vice versa. This is significant since it indicates whether a corporation has difficulty paying its bills.
No commercial transactions or operations are overlooked
Staff can utilise double-entry bookkeeping to verify that no company transactions or activities are overlooked by comparing the current period’s financial accounts to those from previous periods. If there are any discrepancies, it is possible that a colleague overlooked a transaction or that information was misreported.
Correctly categorising all revenues and expenses
Because it allows them to evaluate the trial balance, double-entry bookkeeping can assist staff in ensuring that all revenues and expenses are appropriately classified. The trial balance is a list of all accounts and their respective balances. If it does not match the accounts recorded on the general ledger, it indicates that a mistake has occurred somewhere.
Which Software Works with the Double-entry Bookkeeping System?
A double-entry accounting software program, which usually contains features such as a general ledger, accounts receivable and payable, and a trial balance, assists you in keeping track of your financial operations.
Popular double-entry bookkeeping software:
Advantages of Double-entry Bookkeeping System
1. Provides a Comprehensive Financial Picture
Small firms can utilise double-entry accounting to track their financial health and the rate at which they are growing. This bookkeeping system records every financial transaction to prevent fraud and confusion.
A double-entry accounting system is required for any business with more than one employee, inventory, debts, or many accounts.
Businesses that fit these characteristics require the comprehensive financial picture that double-entry bookkeeping provides. Double-entry accounting may generate important financial reports, such as balance sheets and income statements.
2. Improved cash flow management
A double-entry system improves cash flow management by tracking and recording all financial transactions. This involves recording each transaction, one on the credit side and one on the debit side, to provide a complete and accurate transaction record.
It improves cash flow management and provides a clear and detailed picture of a business’s financial activities. It also assists with unnecessary expenses and develops strategies for improving cash flow.
3. Helps in Better Financial Decisions
Financial accounts from double-entry bookkeeping reveal how successful small businesses are and how financially robust certain aspects of their business are. You can check your spending and get a report on the financial health of your business.
By delivering precise and timely information about your company’s financial position, the double-entry accounting system can help you make smarter financial decisions.
This data can be used to make educated decisions regarding how to distribute resources, how much debt to incur, and whether to invest in new projects.
4. Errors in Bookkeeping Reduced
In double-entry bookkeeping, liabilities and equity (net worth or “capital”) must match assets when creating a balance sheet. If they don’t, your books are incorrect.
This failsafe alerts businesses when their journal entries are incorrect. This accounting system also makes it easier to identify and remedy problems. The double-entry approach is also a more transparent means of keeping your books and aids in the accountability of firms.
5. Appreciated by Statutory Bodies, Investors, Banks, and Buyers
The double-entry system is complete and transparent. It makes it easier for firms to attract investors and secure finance. The reports generated by the double-entry bookkeeping system provide banks and investors with a thorough and accurate picture of the business’s financial health. The Income Tax Department prefers this bookkeeping system. The statutory bodies that control enterprises, such as the Registrar of Companies, SEBI, and the RBI, all accept the double-entry bookkeeping system.
6. Ready for Tax Preparation at Year-End Closing
Tax preparation at the end of the year often entails analysing the financial transactions that occurred throughout the year and determining which transactions are taxable. It must be recorded on the company’s tax return. The following steps are frequently involved in the double-entry process:
- Be prepared for year-end tax filing.
- It ensures that each entry is balanced. This reduces the possibility of errors, saving time and money when filing taxes.
- Finally, double-entry accounting helps with cash flow management. This ensures the correctness and completeness of the financial records and makes preparing the tax return easier.
Related blog – What is Bookkeeping and How is it Important for your Business?
Documents for Recording Transactions
The income and expenses for transactions are entered in a cash register in single-entry accounting. In contrast, the double-entry method begins with a diary, followed by a ledger, a trial balance, and financial statements.
- Journal: An accounting book (journal) that records transactions consecutively and chronologically.
- Ledger: A book of final entries in which transactions are separated and documented in distinct accounts. It needs to be balanced.
- Trial Balance: It is a bookkeeping worksheet showing all ledger accounts’ credit and debit balances. The trial balance is significant because it preserves the arithmetic precision of transactions.
Drawbacks of double-entry bookkeeping (accurate & concise)
While double-entry is the standard and reliable method, it has some disadvantages small businesses should know:
- Requires accounting knowledge / training – It’s more complex than single-entry; staff need basic accounting skills to post correct journal entries.
- More time and cost – Setting up ledgers, reconciliations and using software or staff may cost more than very simple single-entry bookkeeping.
- Classification errors still possible – Misclassifying accounts or posting to the wrong ledger can still cause wrong reports; the trial balance helps detect but not automatically fix classification mistakes.
- Initial setup complexity -For micro businesses with very few transactions, double-entry can be over-engineered unless automated with software.
On A Final Note
Double-entry accounting is a very efficient and effective way of recording financial transactions. While it is more challenging to execute than single-entry accounting and requires more effort and precision, it provides various benefits that make it worthwhile. It maintains an accurate, up-to-date record of financial transactions and makes comparing income and expenses easier. It also enables faster identification of flaws and anomalies, making detecting and correcting problems easier.
Despite its numerous advantages, the double-entry system has several disadvantages. If not done properly, it may become more time-consuming and difficult, leading to errors and discrepancies. Furthermore, it might not be suitable for small businesses or organisations with limited resources.
Overall, the double-entry system is an effective and efficient means of documenting financial transactions; nevertheless, it is necessary to consider the benefits and drawbacks before using it. With proper training and guidance, the help of the double entry system may be well worth the effort.
Related post – Extended Trial Balance
Frequently Asked Questions
What exactly is a double-entry system?
Can we employ both single and double-entry bookkeeping simultaneously?
Is substantial accounting knowledge required for double-entry bookkeeping?
Parul is a dedicated writer and expert in the accounting industry, known for her insightful and well researched content. Her writing covers a wide range of topics, including tax regulations, financial reporting standards, and best practices for compliance. She is committed to producing content that not only informs but also empowers readers to make informed decisions.