What is double entry bookkeeping?

Managing a business's money is tricky and needs careful attention. Double-entry bookkeeping is a reliable accounting method that helps businesses everywhere, including Australia, keep their finances in order and under control.

Post-thumb
- 5 min read

Managing a business’s money is tricky and needs careful attention. Double-entry bookkeeping is a reliable accounting method that helps businesses everywhere, including Australia, keep their finances in order and under control.

Double-entry bookkeeping records each transaction in two accounts, with equal debits and credits to maintain balance.. For every debit in one account, there must be a corresponding credit in another. This method uses the accounting equation: Assets equal liabilities plus equity, a fundamental financial principle.

Imagine your business is a tree. Just as a tree’s strength is hidden within its roots, the roots of your business’s financial stability lie in a well-maintained set of books. Double-entry bookkeeping ensures that the tree remains upright by meticulously tracking where money comes from and where it goes. This system offers a detailed financial perspective, crucial for thorough analysis and decision-making.

Read also: What is bookkeeping?

The contrast: what is single-entry bookkeeping?

On the other side of the ledger, single-entry bookkeeping is the simpler cousin of double-entry. It records each transaction as a single entry, much like a chequebook or a personal banking statement. Each transaction affects only one ledger account and is entered once, either as income or as an expense.

This method may be likened to a single page in a novel. While it tells part of the story, it doesn’t show how one page relates to the next. For very small businesses with straightforward transactions, single-entry bookkeeping might suffice. However, it lacks the comprehensive financial story and the error-checking mechanisms inherent in double-entry bookkeeping.

How are the accounts structured?

In double-entry bookkeeping, the structure of accounts is implemented through a system known as the Chart of Accounts (COA). The COA is an organised list that categorises every account used to record transactions in a company’s general ledger. These accounts are typically sorted into five main types, which reflect the company’s various financial elements:

Assets: These accounts represent what the company owns and will receive in the future. Assets include cash, inventory, accounts receivable, and fixed assets like property, plant, and equipment.

Liabilities: These accounts capture what the company owes to others. Liabilities cover loans, mortgages, accounts payable, and other forms of debt.

Equity: Also known as shareholder’s equity or owner’s equity, this reflects the residual interest in the assets of the entity after deducting liabilities. It can include common stock, retained earnings, and additional paid-in capital.

Revenue: Also called income, revenue accounts document the company’s earnings from business activities, like sales and service income.

Expenses: These accounts track the costs incurred by the company’s operational activities. Expenses include wages, rent, supplies, and depreciation.

Transactions are recorded in their respective accounts through journal entries that show the date, a brief description, and the amount to be debited or credited. Each journal entry affects at least two accounts – one is debited and the other credited for an equal amount, maintaining the balance stipulated by the accounting equation.

How to do double-entry bookkeeping?

In practice, double-entry bookkeeping requires meticulous attention to detail. Further, you must first identify which accounts are affected by each transaction and then record corresponding entries in the appropriate debit and credit columns. Regularly reconciling these entries is vital for ensuring that your total debits equal your total credits, which confirms that your accounts are balanced.

This approach is at the heart of robust financial management and is indispensable for any business aiming to maintain order in its financial affairs. Here’s a concise guide on implementing double-entry bookkeeping:

Understand the Core Accounts: Double-entry bookkeeping involves the following five categories of accounts: assets, liabilities, equity, expenses, and revenue. Each financial transaction will affect at least two of these accounts.

Determine Debits and Credits: Every transaction will involve a debit to one account and a credit to another, maintaining the accounting equation where Assets = Liabilities + Equity. The rules for increasing or decreasing an account’s balance through debits and credits depend on the account type.

Keep Rigorous Records: Document detailed information for every financial transaction, including dates, amounts, and accompanying documentation such as receipts or invoices.

Read the Chart of Accounts: The chart of accounts is a comprehensive list of all accounts used by the business. Use this as a guide for categorising transactions.

Make Journal Entries: Record transactions initially in a journal, noting the accounts affected and whether they are debited or credited.

Post to the Ledger: Transcribe entries from the journal to the general ledger where the cumulative totals of debits and credits for each account will show.

Verify the Balances

Ensure that the sum of debits equals the sum of credits, which means the books are balanced. Unbalanced books may indicate recording errors that need to be investigated.

Consistently applying these steps ensures accurate financial records vital for business management and regulatory compliance.

The importance of double-entry bookkeeping

Double-entry bookkeeping shines in its ability to provide a complete and balanced financial picture of a business. Below are the key benefits Australian businesses can reap from adopting this accounting method:

Accuracy: Errors are easier to spot because the system naturally prompts a check for balance; if accounts do not balance, the error needs to be located and corrected.

Financial Clarity: It allows for the preparation of accurate balance sheets, profit and loss statements, and other financial documents that present a clear picture of business performance.

Accountability: Every transaction has a dual effect, creating a transparent audit trail and reducing the risk of financial mismanagement or fraud.

Informed Decision-Making: By reflecting both sides of each transaction, business owners and managers can make better-informed decisions based on comprehensive financial data.

Read also: What does a bookkeeper do?

Embracing double-entry bookkeeping

Adopting double-entry bookkeeping boosts your business’s financial accuracy and integrity. Double-entry bookkeeping is the cornerstone of sound financial management in businesses, large or small. It encapsulates the full story of a company’s financial comings and goings, ensuring every detail is accounted for. For growth and financial clarity in Australian business, double-entry bookkeeping is essential.

Embarking on the journey of double-entry bookkeeping marks a commitment to fiscal accuracy and accountability. With the right approach and tools, Australian businesses can navigate the waters of financial transactions with confidence and precision.