In this lesson, we are going to learn the double entry accounting system or double entry bookkeeping.
It is one of the basic foundations upon which the steps in the accounting cycle and other accounting principles are based.
The double entry accounting system emerged as a result of the industrial revolution. Merchants in the olden times recorded transactions in simple lists, similar to what we call today as single entry method.
Through the ages, business became more and more complex, hence, the development of more effective ways to keep track of business transactions. The first accounts of the double entry bookkeeping system was documented by Luca Pacioli, a Franciscan monk and hailed as the Father of Modern Accounting.
Under the double entry bookkeeping system, business transactions are recorded with the premise that each transaction has a two-fold effect – a value received and a value given.
To better understand the double entry method, let us first take a look at the single entry system.
Single Entry Bookkeeping
The single entry bookkeeping system does not explicitly record the two-fold effect of transactions. Under this method, separate books are maintained for the company's basic accounts such as cash, receivables, and payables. Therefore, the accounting records are incomplete.
For example, consider the following transactions:
- On October 1, 2016, Mr. Briggs invested $30,000 to start a marketing consultancy business.
- On October 5, the company purchased a computer for the office, $1,000.
- On October 8, the company rendered services and received $500.
Under the single entry, the company may use a cashbook to record its cash receipts and disbursements. After recording the above transactions, the cashbook will look this:
|10-01-2016||Beginning balance||$ 0.00|
|10-01-2016||Investment of owner||$ 30,000.00||30,000.00|
|10-05-2016||Purchase of computer||(1,000.00)||29,000.00|
|10-08-2016||Cash from customer||500.00||29,500.00|
We can readily determine the cash balance using this recording method. However, it will be difficult to determine the balances of other accounts such as revenues and expenses unless the company maintains separate books for them as well.
An important note to consider here is that a valid set of financial statements can still be prepared even if the accounting system is incomplete. But, it will require additional work to reconstruct the accounts to conform to the double-entry method.
Double Entry Bookkeeping
Under the double entry method, every transaction is recorded in at least two accounts. Once all transactions are processed into the accounting system, the balances of all accounts will be readily available.
All accounts have a debit and a credit side. Debit means left and credit means right.
Because of the two-fold or duality effect of transactions, the total effect on the left will always be equal to total the effect on the right. Hence, the famous line "debit equals credit".
Now, here is the rule: To increase an asset, you debit it; to decrease an asset, you credit it. The opposite applies to liabilities and capital. To increase a liability or a capital account, you credit it; to decrease a liability or capital account, you debit it. Expenses are debited when incurred and income is credited when earned.
Here's a table to summarize that:
|Accounting Element||To Increase||To Decrease|
|3. Capital investment||Credit||Debit|
|4. Capital withdrawal||Debit||Credit|
Tip: If you are having a hard time remembering the table above, you actually only need to familiarize yourself with the "To Increase" part. The action to decrease the accounts is simply the opposite of the action to increase them.
Transactions are recorded using journal entries in the journal. A journal entry is a record showing the date of the transaction, the account/s debited, the account/s credited, their respective amounts, and an explanation to describe the transaction.
Using the transactions presented earlier, the journal would look like this:
|Mr. Briggs, Capital||30,000.00|
|To record initial investment.|
|To record purchase of computer.|
|To record cash for services rendered.|
As mentioned earlier, every transaction has a two-fold effect. Thus, each transaction is recorded in at least two accounts. Notice the two-fold effects in the above examples.
You will learn how to prepare journal entries in another lesson. For a head start, let us take a look at how we came up with the journal entry for the first transaction. In that transaction, Mr. Briggs invested $30,000 to start a marketing consultation business on October 1, 2016.
- Place the date of the transaction on the leftmost side of the journal.
- Determine the account to be debited and the amount. In this case, there is an increase in cash because of the contribution. To increase cash, an asset account, we debit it. So, we would then record Cash and place the amount, 30,000 on the debit column.
- Next, we determine the account credited. We are recording the owner's initial contribution. It increases the company's capital; therefore we would credit the capital account – Mr. Briggs, Capital, and place the amount in the credit column. Credits are recorded below the debits. Also, notice the indentions used.
- Finally, provide a brief explanation at the end of the entry.
See if you can figure out the logic behind the other two journal entries.
After recoding the transactions, we now have a running record of all accounts, and hence a complete accounting system.
In addition to the journals, some companies maintain separate books for some of their important accounts for better control.
The preparation of journal entries through the double entry bookkeeping method, along with the other steps in the accounting cycle, results in a more systematic accounting system. You will learn more about journal entries in detail, including how to prepare them, and the rest of the steps of the process in later lessons.