Double Entry Accounting
True to its name, double-entry accounting is a standard accounting method that involves recording each transaction in at least two accounts, resulting in a debit to one or more accounts and a credit to one or more accounts. The value of the transactions in each case will balance out, ensuring that all dollars are accounted for and the accounts are balanced. Debits are typically noted on the left side of the ledger, while credits are typically noted on the right side.
Large firms must use double entry system of accounting, as it's required by law. It's also necessary as it is the most efficient way for a company to monitor its financial growth, especially as the scale of business grows.
Examples of Double Entry Accounting
As an example of how double entry accounting works, if you were going to record earnings of $500, you would need to make two entries: a debit entry of $500 to an account called "Cash" and a credit entry of $500 to an account called "Revenue." Another example might be the purchase of a new computer for $1,000. In this example, you would need to enter a $1,000 debit to your "Technology" account and a $1,000 credit to your "Cash" account.
The opposite also holds true: If your company borrows money from a bank, your assets will increase but your liabilities will increase by the same amount. Double entry accounting provides a method for quickly checking accuracy because the sum of all accounts with debit balances should equal the sum of all credit balance accounts.
It also helps minimize errors and increase the chance that your books balance.
Double Entry Accounting Encourages Accuracy
As a company's business grows, the likelihood of clerical errors increases. Although double entry accounting does not prevent errors entirely, it will limit the effect any errors have on the overall accounts.
Because the accounts are set up to constantly check each transaction to be sure it balances out, errors will be flagged to accountants quickly, before the error produces subsequent errors in a domino effect.
Using Accounting Software With Double Entry Accounting
The best accounting software for business uses double-entry accounting; without that feature, an accountant will have difficulty preparing year end and tax records. Double entry accounting is a "must have" feature in financial software for small businesses. While not required for personal finance management, double entry accounting is useful in personal finance software as well.
Double Entry Account Types
When you employ double entry accounting, you will need to use several types of accounts. Below are some key account types.
- Asset accounts represent something you own, such as your checking account or the unmortgaged portion of your home.
- Liability accounts are something that you owe, like a mortgage, car loan or credit card balances.
- Income accounts represent money you receive.
- Expense accounts are money you spend.
Double entry accounting is a must for all large or growing companies. Using this method of accounting will assist the bookkeeping and accounting staff in minimizing errors and offering an overall picture of a business's financial outlook.
It's a crucial element to providing a big-picture overview to a company's key financial decision makers.
Learn More About Accounting Methods
- Double-Entry Bookkeeping Vs. Single-Entry Accounting Method
- What Is Best: Single-Entry or Double-Entry Bookkeeping?