Double Entry Accounting

Double Entry Accounting Explained

Just what is Double Entry Accounting?

Double-entry accounting is a system of bookkeeping that records every financial transaction twice, once as a debit and once as a credit. This system ensures that the total debits always equal the total credits, which helps to maintain the accuracy of financial records.

Double-entry accounting is based on the following accounting equation:

Assets = Liabilities + Equity

This equation states that the total assets of a business must equal the total liabilities plus the total equity. Assets are resources that a business owns, such as cash, inventory, and equipment.

Liabilities are debts that a business owes, such as accounts payable and loans.

Equity is the ownership interest in a business, which is calculated by subtracting liabilities from assets.

Every financial transaction affects at least two accounts in the accounting equation. For example, when a business sells a product on credit, the asset account “Accounts Receivable” increases and the revenue account “Sales” increases. When a business pays a bill, the asset account “Cash” decreases and the liability account “Accounts Payable” decreases.

Double-entry accounting can be complex, but it is an essential tool for businesses of all sizes. It helps businesses to:

• Track their financial performance
• Make informed decisions
• Comply with tax laws

Here is a simplified example of a double-entry accounting transaction:

Transaction: A business sells a product for £100 on credit.

Debits: Accounts Receivable (£100)

Credits: Sales (£100)

This transaction increases the asset account “Accounts Receivable” by £100 and the revenue account “Sales” by £100. The total debits and credits are equal, which maintains the balance of the accounting equation.

Double-entry accounting is a powerful tool for businesses to manage their finances and make informed decisions.

Components of Double Entry Accounting

In double entry accounting, there are several key components that form the foundation of the system. These components help ensure accuracy and reliability in recording financial transactions.

A. Cash as a Fundamental Element in Double Entry Accounting

Cash is considered a fundamental element in double entry accounting. It serves as the backbone of the entire system, as it represents the actual money flowing in and out of a business. All financial transactions involving cash must be recorded accurately to maintain the integrity of the accounting records.

B. Debits and Credits: Building Blocks of Double Entry Accounting

Debits and credits are the building blocks of double entry accounting. They form the basis for recording and analysing financial transactions. Understanding how debits and credits work is crucial in maintaining the balance and accuracy of the accounting system.

1. Definition and Significance of Debits and Credits

Debits and credits are two opposite sides of the same coin in double entry accounting. They represent increases and decreases in specific accounts. Debits are used to record increases in assets and expenses, while credits are used to record increases in liabilities, equity, and revenue. The significance of debits and credits lies in their ability to keep the accounting equation in balance. For every transaction, the total debits must equal the total credits, ensuring that the equation Assets = Liabilities + Equity remains intact.

2. Rules for Recording Debits and Credits in Transactions

There are specific rules for recording debits and credits in transactions. These rules, often referred to as the “golden rules” of accounting, ensure that the accounting equation remains balanced and accurate:

• Assets and expenses increase with debits and decrease with credits.
• Liabilities, equity, and revenue increase with credits and decrease with debits.

By following these rules, accountants can maintain the balance and integrity of the double entry accounting system.