Double-Entry System of Bookkeeping

A double-entry bookkeeping system is where a corresponding entry is made for every transaction, i.e. debits and credits. The basis of the double-entry bookkeeping system is that every transaction has two parts and affects two ledger accounts. The double-entry system of bookkeeping deals with two or more accounts for every business transaction. 

For example, if a company enters into a transaction of borrowing money from a bank, there will be two entries as an asset and a liability. This is because it will increase the assets for the cash balance account and also increase the liability for the loan payable account. 

Thus, all financial transactions have an opposite and equal entry in at least two different accounts. The double-entry system of bookkeeping is widely used, and it includes detailed descriptions of the services and products, expenses, income, bad debt, loans, etc.

One of the fundamental equations of accounting is – Assets = Liability + Equity. The total of both sides of the equation should be the same. If the total assets are not equal to the total liabilities plus capital, then there is a mistake in the books of accounts. Thus, every transaction has two entries, and if the liabilities increase, then the assets must also increase for the books to be balanced.

Principles of Double-Entry System of Bookkeeping

The principles to be followed while recording the double-entry system of bookkeeping are as follows:

• Debit is written to the left, credit on the right
• Every debit must have a corresponding credit
• Debit receives the benefit, and credit gives the benefit

There are rules to be kept in mind while posting the double-entry transactions in the bookkeeping process. The following are the rules for the different types of accounts:

• For Personal Accounts: Debit the receiver, credit the giver
• For Real Account: Debit what comes in, credit what goes out
• For Nominal Account: Debit all the expenses, credit all the incomes

Personal Accounts are general ledger accounts related to persons like individuals, associations and firms. The Real Accounts are general ledger accounts connected with assets and liabilities other than individuals and people. The Nominal Accounts are general ledger accounts relating to all expenses, incomes, gains and losses.

Journal Entries of Double-Entry System of Bookkeeping

Every transaction entered in a journal involves a debit entry in one account and a credit entry in another account. Thus, every transaction should be recorded in two accounts. The transaction recorded in two accounts reflect the debit in the account that receives value and credit in the other account that has given value.

The main rule for the double-entry system entry is ‘debit the receiver and credit the giver’. The debit entry for a transaction will be on the left side of the general journal, while the credit entry will be on the right side of the journal. The total of debits and credits should be equal for the transactions to be balanced.

The following table shows an example of the double-entry of transactions in a journal.

In the above table, the first entry is the entry of salary paid. As the salary is a nominal account, the rule is to debit all expenses and cash, being a real account, is credited as the cash payment reduces the asset. 

The next entry is the electricity bill that is paid. Since the electricity bill is a nominal account, the expense of the bill is debited, and the cash account is credited, being a real account.

The third entry is of vehicle bought by the business. Since the vehicle is an asset and a real account, the incoming asset (vehicle) is debited, and the cash paid through a bank account for the vehicle is credited. 

The above examples of journal entries show the double-entry of transactions, as per the rules of debit and credit for the respective accounts.

Advantages of Double-Entry System of Bookkeeping

Every business needs to have a bookkeeping system. Though small companies might opt for a single-entry system of bookkeeping, it is necessary for the companies with more than one employee or that has debts, inventory or several accounts to have a double-entry bookkeeping system. The advantages of the double-entry system of bookkeeping are as follows: 

Complete financial picture

The business whose transactions are huge should maintain a double-entry bookkeeping system. This is because double-entry bookkeeping helps to prepare crucial financial reports like an income statement and balance sheet. It gives complete information about all the transactions compared to the single-entry system, as every transaction consists of a source and destination. 

Better financial decisions

The double-entry system helps companies maintain their accounts in detail, which helps control the business. In addition, it shows how profitable and financially strong various parts of the business are and thus helps to make better financial decisions.

The detailed records of accounts maintained under the double-entry system can also be used for comparison purposes. The details of the previous year can be compared with the details of the current year, and any deviations found during comparison can be worked on.

Reduces bookkeeping errors

The assets and liabilities plus equity in the balance sheet of the double-entry bookkeeping system should be equal. If they are not equal, the entries in the books are wrong and indicate that the journal entries are wrong. Thus, the double-entry system ensures accuracy in the books of accounts and the final balance sheet. In addition, it helps accountants to reduce mistakes by being accurate.

Preferred by statutory bodies and banks 

The double-entry system is more transparent and complete. It helps businesses to gain investors and obtain credit easily. The reports prepared by the double-entry system of bookkeeping allow banks and investors to get a complete and accurate picture of the business’s financial health. The Income Tax Department prefers this system of bookkeeping. The statutory bodies governing businesses such as Registrar of Companies, SEBI, RBI, etc., also accept the double-entry system of bookkeeping.