Double Entry Bookkeeping

One of the terms used often in small business accounting is double entry bookkeeping, but what does it mean?

Double-entry bookkeeping is the process most businesses use to produce their financial statements. If a transaction takes place, at least two entries need to be made: a debit and a credit. A simple example is that if a sales invoice is issued, there will be an entry in the sales (profit and Loss Account), and the customer account increased (Debtors).

When making any debit or credit, an equal and opposite transaction must take place. The total debits and credits must balance.

By completing double entry bookkeeping, the business can track stock, debtors, creditors, banks, assets, and liabilities much easier than using a single-entry system. This is essential for Limited Companies to submit year-end accounts to Companies House.

Single Entry Bookkeeping

The other method of accounting is the single-entry method. It is bookkeeping in its simplest form and might only include the income and expense account. The advantage of using single-entry bookkeeping is that it’s cheap and easy to use.

The Accounting Equation

To help understand double entry bookkeeping, you need to look at the accounting equation. The equation must always balance.

Below are some of the general accounts that make up each of the items on the equation.

Assets Account – These are accounts that a business owns, including bank, cash, accounts receivable, computers and prepayments.

Liability Account – Accounts that the business owes, including loans, accounts payable, taxes due and accruals.

Equity Account – Includes owner’s equity, shareholders’ investments and retained earnings.

To help understand the equation better, we will look at an example. A business transaction is made; the company purchase a new computer for 500.00 on credit. The computer is classed as an asset and will increase the asset account. The accounts payable account will also increase by an equal amount; therefore, the equation remains balanced.

When making a double entry transaction, you may make the adjustments on the same side of the equation. If using the example of purchasing a computer at 500.00, they use the bank account instead of using credit. Both the computer and bank are assets. The adjustments are made on the same side of the equation and remain balanced.

Double Entry Accounting Trial Balance

A Trial balance will show all the account balances for the general ledger. It includes all the debits and credits from the Profit and loss and balance sheet reports.

A trial balance helps to check for mistakes in the accounts. The trial balance should be equal on both sides; if not, an error has been made. If mistakes are made, a journal entry can be made to correct them.

You can also check the figures by looking at the individual accounts like the bank, making sure the value in your accounts is the same as the figure on your bank statement on the same date. Adjustments may be made for cheques not cleared or deposits are not showing on the bank statement.

One advantage is that it helps to minimise errors in the accounting system compared to a single-entry system. A single entry system shows income, expenditures, and bank balance. It’s the most straightforward and cheapest form of accounting. Small businesses and non-profit organisations mainly use it.

Double Entry Accounting Example

Below are two double entry bookkeeping examples:

A business buys stock for £700 using its bank account; two things need to happen – the bank balance needs to be reduced by £700, and the stock or inventory needs to be increased by £700.

Our second double-entry bookkeeping example is for a business that invoices a customer (the debtor) for £200 for services for payment at a later date. Increase the accounts receivable account by £200 (Debit), and increase sales by £200; the sales figure will make up part of the retained earnings on the balance sheet, which will post as a credit.

Double Entry Bookkeeping – Financial Statements

Once all the transactions are complete, the financial statements are produced.

There are two main financial statements: the Profit and Loss Statement or Income Statement and the balance sheet.

Balance Sheet

A balance sheet is a financial statement that provides a snapshot of a business’s financial position at a specific point in time. It shows the company’s assets, liabilities, and equity. Assets represent what the company owns or controls, liabilities indicate what the company owes to others, and equity reflects the owner’s stake in the company.

Income Statements Accounts

The Income Statement, also known as the Profit and Loss Account, is a financial report for a company’s financial performance over a specific period. It consists of income, cost of sales, and expense accounts. The income section details the revenue generated from the company’s core business activities, while the cost of sales accounts for the expenses directly related to producing goods or services sold. The expense accounts cover the operational costs not directly tied to production, such as administrative and marketing expenses. This statement provides a comprehensive overview of the company’s profitability by subtracting the total expenses from the total income to determine the net profit or loss.

Using both of the reports will help a business make financial decisions. They are also used to produce end-of-year accounts.

Double Entry Bookkeeping System

Many different software packages will complete the bookkeeping double entry system for you. For most businesses, there are several choices; these include using Excel, FreshBooks, Xero, QuickBooks or other online accounting services.

The advantage of software for your accounts is that the figures are calculated for you. As you complete your transaction, the numbers automatically post to the accounts. An example of this is if you raise an invoice for a customer. Completing an invoice from the software will automatically complete the posting for you, increase your sales, and increase your customer’s balance.

Use our free tool to compare accounting software.

What are the Benefits of Using Double Entry Bookkeeping

Accuracy

Accounts are more accurate by posting transactions to the correct account. By adding a purchase invoice, the software will post to accounts payable and expense accounts.

Reduces Bookkeeping Errors

By using Double entry bookkeeping, you will help to reduce errors in the accounting process. It produces accounts like the bank that can be checked and balanced. Human errors can still be made but are reduced. If an error is made, journal entries are completed to correct them. When producing a journal, the debit entries will equal the credit entries.

Audit Trail

All the posted transactions will leave an audit trail; it helps if you look for any adjustments. An example is looking at the assets account, and the balance seems too high. It is then possible to look at the audit trail and see a list of all the transactions for the assets account.

Double Entry Where to Get Help

Double entry can be complicated to grasp if you are planning to do your accounts; it may be worth investing time in an accounting course or reading some of the books available. We have compiled a list of our top five accounting and bookkeeping books.

If you are stuck, you may need to get someone in to do the bookkeeping for you. It is not worth getting it wrong it may cost more time and money to get an accountant to put it right. If you have an accountant, it is worth contacting them for any recommendations that they may have to get you started.

Double Entry Accounting Summary

Understanding double entry bookkeeping is essential; it comprises debits and credits, which must be equal. There will be a debit entry for each credit entry, and both sides will be an equal amount.

There is a bookkeeping equation: Assets = Liabilities + Equity

A double entry bookkeeping system makes it easier to produce accounting reports and reduces errors. The easiest way to set up a double entry system is to use accounting software.

Further reading on double entry accounting is available on the Accounting Coach website.

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