Guide To Double-Entry Accounting (With Examples)
By Anastasia Hinojosa
Updated October 6, 2021 | Published February 4, 2020
Updated October 6, 2021
Published February 4, 2020
Anastasia Hinojosa is an experienced financial accountant with degrees from Texas A&M-Corpus Christi and Columbia University. She has worked in the healthcare field for over ten years.
Accurate bookkeeping is essential for tracking where and when a company spends and earns its money. While a single-entry accounting system may be appropriate for some small businesses, a double-entry accounting system may be required to ensure you’re getting a complete picture. In this article, we'll explain what double-entry accounting is, how it differs from single-entry accounting, list benefits and give examples of double-accounting.
Related: Learn About Being an Accountant
What is double-entry accounting?
In a double-entry accounting system, transactions are composed of debits and credits. The debits and credits must be equal in order for the system to remain balanced.
For example, if a business pays its electricity bill for $1,200, then it will record an increase to “utilities expense” and a decrease to “cash”.
The ledger entry would be:
Debit utilities expense
The Accounting Equation, which will be discussed later, recognizes three main categories of accounts: assets, liabilities, and equity. General ledger entries to these accounts are recorded like this:
Asset accounts: Record an increase with a debit and a decrease with a credit.
Liability accounts: Record an increase with a credit and a decrease with a debit.
Equity accounts: Record an increase to equity (revenues) with a credit and a decrease to equity (expenses) with a debit.
What is the difference between double-entry and single-entry accounting?
Single-entry accounting is used primarily by sole practitioners, contractors and small businesses to track income and expenses. In these situations, there are a limited number of transactions to track. Double-entry accounting is the preferred method for more complex business accounting scenarios because it provides a comprehensive view of your company's finances.
The main benefit of single-entry accounting is its simplicity. Freelancers and sole proprietors use this system by recording business transactions in a single ledger. The most common single-entry system is a checkbook with income and expenses being added or deducted to a running cash balance. An income statement can be generated from a single-entry system, but records for assets and liabilities necessary to create a balance sheet are not maintained.
However simple, single-entry does have many drawbacks. Some of those include:
Inability to track liabilities or assets
Prone to errors
A double-entry system gives accountants a comprehensive view of a company's financial situation, allowing them to create statements of retained earnings, income statements, statements of cash flow and balance sheets. This system also allows you to assign profits to specific items, which can inform you about high-performing products and allow you to alter future business activities.
Related: 80 Common Accounting Terms
How double-entry accounting works
The double-entry process follows this accounting equation:
Assets = Liabilities + Equity
If your assets do not equal your liabilities and equity, then you know you have made a mistake in your bookkeeping. This formula also reminds us that debits do not always refer to decreases in an account, just as credits do not always refer to increases. However, debits are always listed on the left side of the account ledger and credits are listed on the right.
Understanding when to use credits and debits can be confusing, so here are some key differences:
Recorded on the left side of the account ledger
Makes increases to expense or asset accounts
Makes decreases to revenue
Makes decreases to liability or equity accounts
Recorded on the right side of the account ledger
Makes decreases to expense or asset accounts
Makes increases to revenue
Makes increases to liability or equity accounts
|Recorded on the left side of the account ledger||Recorded on the right side of the account ledger|
|Added to expense or asset accounts||Deducted from expense or asset accounts|
|Deducted from revenue||Added to revenue|
|Deducted from liability or equity accounts||Added to liability or equity accounts|
Publicly-held accounting firms are required by generally accepted accounting principles, also known as GAAP, to use a double-entry accounting system. The methods found in GAAP are maintained by the Financial Accounting Standards Board, or FASB, which is an entity that is unaffiliated with the government.
Benefits of double-entry accounting
There are many benefits associated with double-entry accounting. Some of those include:
Decreases the likelihood of bookkeeping mistakes.
Finances become increasingly easier to visualize and navigate.
Adds a level of accountability to your company's finances.
Business is taken more seriously by potential buyers, banks and investors.
Provides insight into a company's profitability.
Tracks your company's financial growth.
Allows you to appropriately scale the business as it grows.
Types of accounts in double-entry accounting
Per the accounting equation, the three main types of accounts in double-entry accounting are assets, liabilities and equities. These can be further subdivided into contra accounts and income statement accounts.
Here are some accounts you may encounter and examples of each:
Liabilities: These accounts provide information about expenses that have not been paid yet. For example: Accounts payable, Taxes payable and Notes payable.
Assets: These accounts assign monetary value to things the company owns that provide economic value and/or future benefit. For example: cash, accounts receivable and inventory.
Equities: These accounts provide information about the company’s capital or ownership of the business. For example: common stock, treasury stock and retained earnings.
Expenses: These accounts provide information about costs incurred by the business. These accounts are represented in the “equity” section of the accounting equation through retained earnings. For example: utilities, advertising and rent.
Revenue: These accounts track income generated by the business or its assets. These accounts are represented in the “equity” section of the accounting equation through retained earnings. For example: sales revenue, interest income and gain on sale of asset.
Contra: A contra account offsets any of the above accounts. These accounts are used to decrease the balance of an account without directly lowering the account balance. This is useful for more accurate tracking of situations in which accounts are not paid or merchandise is returned. For example: Allowance for doubtful accounts is a contra-asset account that offsets Accounts Receivable whenever a customer most likely will not pay. Sales Returns and Allowances is a contra-revenue account that offsets Sales Revenue whenever an item is returned.
The accounts that a company uses will depend on its business's individual operations. Companies can add and alter accounts to be better-suited for their reporting and accounting needs.
Examples of double-entry accounting
Double-entry accounting ensures that all parts of a transaction are accounted for by providing balances for the credit and debit accounts. These accounts should maintain an equal balance at all times.
Here are some examples of double-entry accounting:
If a company has sales revenue of $300, it will need to make two entries when recording the data:
Debit cash: $300
Credit sales revenue: $300
If a company decides to purchase a $1,200 computer (expensed, not capitalized), it will need to make two entries when it records the data in its ledger:
Debit minor tools and equipment: $1,200
Credit cash: $1,200
A company has taken out a $5,000 loan from their bank to be repaid within 12 months. It will need to increase both their cash and liability accounts by this amount.
Debit cash: $5,000
Credit notes payable: $5,000
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