Double entry bookkeeping - What is double entry bookkeeping?
Double entry bookkeeping is a system of accounting in which every transaction has a corresponding positive and negative entry (debits and credits)
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The double entry system of bookkeeping is based on the fact that every transaction has two parts and that this will therefore affect two ledger accounts.
Every transaction involves a debit entry in one account and a credit entry in another account. This means that every transaction must be recorded in two accounts; one account will be debited because it receives value and the other account will be credited because it has given value.
To make it easier to remember, the main rule is to: "debit the receiver and credit the giver".
Origins of double entry bookkeeping
The double entry system can largely be credited with the development of modern accounting. It defined the methods for accurate record keeping across any industry.
Historical records indicate that the double entry bookkeeping system was first seen used by merchants as early as the Middle Ages. This was a vast improvement from the abacus and early single-entry systems used from the age of Antiquity.
As double entry bookkeeping became more widely used, it extended to include detailed descriptions of products and services, income, expenses, loans, bad debt, etc. Read more about accounting through the ages in our blogpost: ‘Invoicing & accounting: a journey through history’.
In the ledger
Whether hand written or computerised, the ledger contains accounts of each asset and liability of the business and of the capital (amount invested) of the owner, and a separate account is kept for every item involved in business dealings.
The double entry system requires two entries for each transaction: a debit and a credit. Any purchases, such as raw materials or assets, as well as any payments from customers, must all be recorded in two places in the ledger under this system.
For example: John’s business purchases £1,500 of raw materials from a supplier, which he will use to develop products that he will then sell to his customers. When he records this under the double entry system, he would debit his inventory account as an asset, and credit his cash account.
John runs a carpentry business and invoices a customer a dining table for £800. This transaction would be recorded as:
- A debit of £800 in his accounts receivable.
- A credit of £800 to his revenue account.
More detailed accounts would also include a double entry approach to manage inventory and cost of goods sold (COGS):
- A £500 debit to the COGS account
- A £500 credit to the inventory account These entries would allow John to better track his total profit, as the following equation illustrates.
For Every Transaction: The Value of Debits must = The Value of Credits
The accounting equation must balance the totals found in the debit and in the credit accounts:
'Assets + Expenses = Liabilites + Owner’s Equity + Revenue'
So therefore, 'Debit Accounts (Assets + Expenses) = Credit Accounts (Liabilities + Revenue + Owner’s Equity)'.
Debits are on the left and increase a debit account and reduce a credit account. Credits are on the right and increase a credit account and decrease a debit account.
Which side should your entry be on?
Every account has two "sides", a right side and a left side. A debit refers to an entry on the left side of an account, and a credit refers to an entry on the right side of an account. Double entry bookkeeping requires that for every transaction, there is an entry to the left side of one (or more) account, and a corresponding entry to the right side of another account(s).
- Expenses are always debits
- Revenues are always credits
- Debit the cash account when cash is received
- Credit the cash account when cash is paid out
Double entry bookkeeping & Debitoor
Debitoor favours a simple and intuitive approach to accounting. In this vein, the ledger in Debitoor is built in, allowing the entry of credits and debits, but without the tedious balancing of accounts. Instead, Debitoor helps you maintain a constant overview of your income, expenses, and any overdue payments.
It also allows for automatic bank reconciliation through uploading a bank statement, meaning that the payments on your statement are matched to the corresponding invoice or expense, instantly, balancing your accounts.