Understanding Double Entry in Accounting: A Guide to Usage

What Is Double Entry?

Double entry is the bookkeeping principle which states that every financial transaction has equal and opposite effects as both an asset and a liability, and therefore it must be recorded as such in two separate places.

Double entry satisfies the accounting equation:

$\begin{aligned} &\text{Assets} = \text{Liabilities} + \text{Equity} \\ \end{aligned}$​Assets=Liabilities+Equity​

In a double-entry accounting system, credits are offset by debits in a general ledger or T-account.

Understanding Double Entry

In accounting, a credit is an entry that increases a liability account or decreases an asset account. A debit is the opposite. It is an entry that increases an asset account or decreases a liability account.

In the double-entry accounting system, transactions are recorded in terms of debits and credits. Since a debit in one account offsets a credit in another, the sum of all debits must equal the sum of all credits.

The double-entry system of bookkeeping standardizes the accounting process and improves the accuracy of prepared financial statements, allowing for improved detection of errors. All types of business accounts are recorded as either a debit or a credit.

Types of Business Accounts

Bookkeeping and accounting are ways of measuring, recording, and communicating a firm’s financial information. A business transaction is an economic event that is recorded for accounting/bookkeeping purposes. In general terms, it is a business interaction between economic entities, such as customers and businesses or vendors and businesses.

Under the systematic process of accounting, these interactions are generally classified into accounts. There are five different types of accounts that all business transactions can be classified:

• Assets
• Liabilities
• Equities
• Income
• Expenses

Bookkeeping and accounting track changes in each account as a company continues operations.

Debits and Credits

Debits and credits are essential to the double-entry system. In accounting, debit refers to an entry on the left side of an account ledger, and credit refers to an entry on the right side of an account ledger. 

To be in balance, the total of debits and credits for a transaction must be equal. Debits do not always equate to increases, and credits do not always equate to decreases.

A debit may increase one account while decreasing another. For example, a debit increases asset accounts but decreases liability and equity accounts, which supports the general accounting equation of assets = liabilities + equity. 

On the income statement, debits increase the balances in expense and loss accounts, while credits decrease their balances. Debits decrease revenue account balances, while credits increase their balances.

Double-Entry Accounting System

Double-entry bookkeeping was developed in the mercantile period of Europe to help rationalize commercial transactions and make trade more efficient. It also helped merchants and bankers understand their costs and profits. Some thinkers have argued that double-entry accounting was a key calculative technology responsible for the birth of capitalism.

The balance sheet is based on the double-entry accounting system where the total assets of a company are equal to the total liabilities and shareholder equity.

Essentially, the representation equates all uses of capital (assets) to all sources of capital (where debt capital leads to liabilities and equity capital leads to shareholders’ equity). For a company to keep accurate accounts, every business transaction will be represented in at least two of the accounts.

For instance, if a business takes a loan from a financial entity like a bank, the borrowed money will raise the company’s assets and the loan liability will also rise by an equivalent amount.

If a business buys raw materials by paying cash, it will lead to an increase in inventory (asset) while reducing cash capital (another asset). Because there are two or more accounts affected by every transaction carried out by a company, the accounting system is referred to as double-entry accounting.

This practice ensures that the accounting equation always remains balanced; that is, the left side value of the equation will always match the right side value.

Example of Double Entry

A bakery purchases a fleet of refrigerated delivery trucks on credit; the total credit purchase was $250,000. The new set of trucks will be used in business operations and will not be sold for at least 10 years—their estimated useful life.

To account for the credit purchase, entries must be made in their respective accounting ledgers. Because the business has accumulated more assets, a debit to the asset account for the cost of the purchase ($250,000) will be made. 

To account for the credit purchase, a credit entry of $250,000 will be made to accounts payable. The debit entry increases the asset balance and the credit entry increases the notes payable liability balance by the same amount.

Double entries can also occur within the same class. If the bakery’s purchase was made with cash, a credit would be made to cash and a debit to asset, still resulting in a balance.

The Bottom Line

The double-entry accounting method has many advantages over the single-entry accounting method. First and foremost, it provides an organization with a complete understanding of its financial profile by noting how a transaction affects both credit and debit accounts. It also makes spotting errors easier, because if debits and credits do not match, then something is wrong. Lastly, it makes preparing financial statements easier.