Double-entry bookkeeping is a method of recording financial transactions used in Europe since the Renaissance. Developed by a Franciscan monk named Luca Pacioli, it has become the foundation of all modern accounting, from large corporations to small businesses. Pacioli believed you should balance your debits and credits daily to avoid errors—and bookkeepers still practice this today!
In this article, we'll explore how double entry works, why it's so important for financial reporting and why you should use it if you're an independent contractor or small business owner.
Double-entry bookkeeping is the foundation of all accounting.
Double-entry bookkeeping is the foundation of accounting. Accounting is the foundation of business.
As a business owner, having solid accounting processes and accurate books is essential. It helps you make informed decisions about how to grow your business, track expenses, and optimize profits. Without balanced books, you won’t clearly understand your company’s financial health. This can make it challenging to grow and obtain funding.
Simply put, double-entry accounting is the first line of defense in ensuring your accounts are accurate.
What is double-entry accounting?
Double-entry describes a system of bookkeeping where every transaction is recorded in at least two accounting ledgers or accounts. This method centers around debits and credits, which must always balance to ensure every dollar is recognized. Each account can be debited or credited in the transaction, but not both.
What are debits and credits?
The most fundamental principle of double-entry accounting is that debits and credits are always equal. The debit column is typically on the left side of the ledger, while the credit column is on the right.
Debits increase your account balances, such as an asset or expense account.
Credits decrease your assets or expenses.
This means that for every debit or credit recorded in a journal entry, there must be an equal and opposite record in another column on your balance sheet.
For example, if you were recording the deposit of $100 into your business checking account, you'd write "100" in the “Cash” column next to your bank account (a debit). Then you'd write “Deposits” under your bank balance (a credit).
The primary account categories you’ll use in double-entry accounting include:
Assets are the resources your business owns or controls that increase your company’s value, such as your facility or accounts receivable.
Liabilities show what your business owes to others, such as mortgages, loans, and accounts payable.
Expenses reflect the money you’ve spent, including marketing and payroll costs.
Income is money you’ve received, such as sales and rental income.
Equity portrays the actual value of your business and is calculated with the formula: Total Assets - Total Liabilities = Equity.
What is the accounting equation & why is it important?
The accounting equation is the most fundamental component of double-entry bookkeeping and is the foundation upon which all other transactions are built. The accounting equation always balances and can be written as: Assets = Liabilities + Equity (or Current Assets = Current Liabilities + Retained Earnings).
The first part of this equation tells you:
How much cash is available for immediate use—the current assets of your business, and
Where any remaining cash is so you can access it later—a liability or equity account.
The second part tells you what investments others have made in your company (debt) versus their investment in an ownership stake (equity).
These two pieces together indicate what value you have on hand right now and valuable information about what has been invested into your company over time by its stakeholders.
Debits = Credits
If you want to understand double-entry accounting basics, start by ensuring your debits and credits balance. Each transaction should be written so that it affects both sides of the equation equally. If you have more debits than credits after recording all transactions, it indicates an error in the accounting—be sure to review and find the discrepancy.
If you have questions about double-entry accounting or the bookkeeping has become too much for you to manage on your own, contact Check & Balance today by scheduling a free consultation! We’ll be happy to ensure your records are always accurate.