Understanding the double-entry accounting system
The double-entry accounting system is one way a business can record financial transactions in its general ledger. For many businesses, this system provides a more accurate and complete view of financial health and growth. It can also help detect and prevent fraud within the business.
This guide explores double-entry accounting — also known as double-entry bookkeeping — how it works and the differences between double-entry and single-entry accounting.
What is double-entry accounting?
Double-entry is an accounting method where every transaction is recorded twice – once as a debit and once as a credit. It’s based on the concept that every financial transaction has equal and opposite effects in at least two accounts. For example, if you take out a $10,000 business loan, your cash assets increase, but you now also have debt.
Here’s how that transaction would be represented in the general ledger:
Cash (asset account) is debited $10,000.
Debt (liability account) is credited $10,000.
These financial records help balance the general accounting equation:
Assets = Liabilities + Owner's Equity
This formula says that all the assets that a company owns are financed by either debt (liabilities) or the owner’s investment and retained earnings (owner’s equity).
How does double-entry accounting work?
The double-entry accounting method works according to the balance sheet requirement that transactions posted on the debit side (left) must equal the transactions posted on the credit side (right).
The general ledger is the foundation of double-entry accounting and includes all the transaction data to produce financial statements and reports like the income statement, balance sheet and trial balance. Transactions are segregated into accounts for assets, liabilities, equity, income and expenses.
Where the chart of accounts fits in
A chart of accounts is a handy link between daily business activities and the five accounting buckets – assets, liabilities, equity, income and expenses.
When you classify a transaction to a chart of accounts code, it'll filter into the right accounting bucket.
The basic rules of double-entry accounting
The three basic rules of double-entry accounting make sure the accounting equation balances, reducing the likelihood of errors:
Every business transaction must be recorded in at least two accounts (credits and debits).
For each transaction, the total debits recorded must equal the total credits recorded.
Total assets must always equal total liabilities plus equity (net worth or capital) of a business.
While every transaction must be recorded in at least two accounts, the number of accounts on the debit (left) side of the journal entry doesn’t necessarily need to be the same as the number of accounts on the credit (right) side.
The accounts needed for a double-entry system
There are five types of accounts needed for a double-entry accounting system. These five accounts make up your chart of accounts, which is used to generate financial statements.
The five types of accounts used in double-entry bookkeeping are:
1. Assets
What your business owns - like cash, property or equipment
2. Liabilities
What your business owes - like loans or tax
3. Equity
The difference between assets and liabilities
4. Income
Money coming into your business
5. Expenses
Money going out of the business
Double entry accounting example
You own a bakery and you’ve recently purchased several refrigerated delivery trucks totalling $150,000 on credit.
Here’s how that transaction would be recorded using double-entry bookkeeping:
The trucks are an asset, so your assets increase by $150,000, and your account payable also increases by $150,000. You'd debit the asset account and credit the account payable (liability).
When you pay off the $150,000, your account payable decreases by $150,000, and your cash decreases by $150,000. In your general ledger, you debit the account payable account (a liability account) and credit the cash account (an asset account).
What is single-entry accounting?
Single-entry accounting is an accounting system where a business transaction is recorded in only one account, most often incoming or outgoing funds.
Transactions are recorded in a cash book — a journal with columns for transaction details like date, description and whether money is coming in or going out. Each transaction is listed in one column with a positive or negative figure.
Advantages of single-entry accounting
Here are the advantages of single-entry accounting or bookkeeping:
Simple and easy to understand
Single-entry bookkeeping is a simple system, making it ideal for small businesses with limited accounting knowledge and resources.
Time and cost-efficient
Since there’s only one entry for each business transaction, single-entry bookkeeping takes less time and effort to maintain.
Accurate record-keeping
One journal entry per transaction means errors are less likely to occur and it’s easy to keep track of records.
Disadvantages of single-entry accounting
The primary disadvantage of single-entry accounting is that you don’t get a full picture of your finances.
Because you only record one entry per transaction, you can’t see how that transaction impacts other areas of your business, which results in less comprehensive financial reporting. When the end of financial year rolls around, you might miss opportunities to deduct expenses and end up overpaying.
Advantages of double-entry accounting
The advantages of double-entry accounting or bookkeeping include:
Preparing financial statements is easier
The double-entry accounting system shows how transactions affect both credit and debit accounts, which provides a complete financial picture of where and how you’ve spent your money.
Leads to better financial decision-making
This information can be used to generate a variety of crucial financial reports which will help your business make more informed decisions about allocating resources, taking on new debt or investing in new projects.
Helps reduce bookkeeping errors
If your debit and credit accounts don’t match, then you know your numbers are off. This makes it easier to spot mistakes and correct them, and helps prevent fraud and embezzlement.
Investors, banks and buyers prefer it
Double-entry bookkeeping produces reports that give investors, banks and potential buyers an accurate and full picture of the financial health of your business. If you’re asking them for money, they’ll be more likely to say yes if they can see your business is growing and profitable.
Disadvantages of double-entry accounting
The primary disadvantage of double-entry accounting is that it’s a more complex system.
Double-entry bookkeeping requires at least two entries for every single transaction and that debit and credit accounts always equal each other. This complexity can be time-consuming, particularly if it’s a system you’re unfamiliar with.
Double-entry accounting FAQs and resources
Here are some of the most commonly asked questions about double-entry accounting:
Are there always two entries with double-entry accounting?
Yes, double-entry bookkeeping requires at least two entries for every transaction. However, there may be more, depending on the complexity of the transaction.
How do debits and credits work with double-entry accounting?
In double-entry accounting, debits refer to incoming money and credits refer to outgoing money. When you debit one account, another account must have a matching credit of equal value so your books balance.
Who uses double-entry accounting?
In Australia and New Zealand, your annual revenue and assets determine whether your business should report your finances using double-entry accounting (also known as accrual accounting).
Smaller businesses can choose which system to use – either single-entry (cash) or double-entry (accrual) bookkeeping.
Can you switch from single-entry accounting to double-entry accounting?
Yes, it is possible to switch from single-entry to double-entry bookkeeping. However, it can be a complex and time-consuming process as it requires reconstructing the financial records from scratch.
Automate your accounting with MYOB
As your business grows, double-entry bookkeeping will make it easier to track increasingly complex operations and provide clarity on your overall financial health.
With MYOB’s accounting software, you can automate many of the processes involved in single-entry and double-entry bookkeeping and create detailed financial statements — fast. Get started today!
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