double entry accounting

double entry accounting

Importance of Double Entry Accounting

1. Introduction to Double Entry Accounting

Another fundamental element of double entry accounting is balance-driven decisions. These are decisions that take into account the company’s current situation and must be done in such a way as to create entries on both sides of the accounting system. With a company not using the double entry system, this would be impossible since, whatever numbers are the result of the decision, a check on the accounting equation must be done. Choose an asset and liabilities account, and change both balances accordingly. Consulting Partnership Accounting, if you had a distribution of cash to owners, these are recorded on the cash account as well as the capital stock account.

One criticism of double entry accounting comes from profit and loss accounts. Everything recorded on the left hand side of one of these accounts is recorded as a negative nature, thus incurring debt even though no physical transfer of assets has taken place. Critics argue that this is an unacceptable arbitrary, to which supporters counteract by saying that there must be a rule to deal with losses that have occurred.

Another law associated with accounting is Conservation Theory. Conservation Theory states that the total of assets and the total of liabilities and owners’ equity remain equal. This means that in double entry accounting, the sum of debits must always be equal to the sum of the credits. This causes the elements of the last paragraph to hold true. For every entry that represents a sale of goods, there is another entry that represents an expenditure of cash, and for every entry that represents incurring debts, there is an entry to show that the company has an increased owed amount: Debit Cash (Asset) and Credit Revenue (Owner’s Equity).

The double entry accounting system allows a company to make sure that the total assets of the company are always equal to the total of liabilities and owners’ equity (Assets = Liabilities + Owners’ Equity) and that the company’s income is always equal to the expenses plus the company’s change in equity (Income = Expenses + Change in Owner’s Equity). This is what is known as the accounting equation. The reason for the name, double entry system, comes from the fact that transactions are recorded in at least two different accounts. This is more commonly known as journals.

2. Benefits of Double Entry Accounting

A business organization, either small or huge, maintains a proper set of financial records. The person responsible for planned and timely recording of business transactions is called an accountant. The job may not demand any particular eligibility on a mandatory basis to record financial transactions. A monopoly in a business may engage an individual for this job without taking care of any educational criteria. But it is really noteworthy that to grasp the daily transactions of a business unit or a huge organization, basic accounting knowledge is essential. An accounting student at the first level needs to understand the basic functions of accounting – the double entry system of accounting. Furthermore, the words ‘debit and credit’ satisfy this system of accounting mainly. It is therefore essential for an accounting student to know about the debit and credit concept.

Double entry accounting is the basic concept underlying present-day bookkeeping/scorekeeping for maintaining accounting transactions. It is based on a simple philosophy of income and expenses exchange, either cash or kind, and an assumption that every transaction shall have two ‘legs’.

Each accounting entry has two parts – a debit and a credit. Debit refers to the left ledger entry and credit refers to the right ledger entry. The origin of the term goes back to the Venetian merchants. They recorded their business transactions in account books which had two distinct columns – one for debit and the other for credit. Over time and with different geographies, the term came to be known as double entry accounting. Eventually, with more people learning about it and practicing it, the knowledge became credible. Adoption from the accounting world was boosted when Luca Pacioli, an Italian mathematician and a friend of Leonardo da Vinci, detailed the principles of double entry accounting in his book ‘Summa’, first published in 1494. Double entry accounting helps in identifying accounting errors and frauds.

3. Key Principles of Double Entry Accounting

The most important thing to remember about the journal and GL is that they must balance – a double-entry system. If accuracy is required, these totals should be the result of a third person’s software, not the person doing the posting or the independent reviewer. The double entry also allows a check with source documents to see if indeed posted information is not mistaken. If the transactions are not the same, then a third person should evaluate the documents in question by seeing if the transactions add up to the appropriate total. It is here that the third concept is crucial and a source for internal controls. Transactions need to be entered in the company’s balance sheet accounts.

In a double-entry accounting, every transaction affects at least two accounts, and in every case, the total dollar value of the transactions is the same on both the left-hand side and the right-hand side of the accounting equation. The accounting equation involves the three most important financial statements and highlights the left-hand side equals right-hand side property that is fundamental to double-entry accounting. We use three concepts in accounting: the accounting equation, the use of debits and credits for every transaction, and the use of a general journal and a general ledger to record accounts receivable and accounts payable transactions. We will rely on the original journals to post to our General Ledger. These postings (transfers from the original journal to GL) are from our Chart of Accounts. We may have to refer to the proper account by number if our volume is such that we have employees that are cross-trained.

4. Common Mistakes to Avoid in Double Entry Accounting

Double entry accounting is an accounting method employed to balance the process of financial transactions in a given enterprise. As such, ensuring the tallies of both the debit amount and the credit amount will balance the company’s books. It is surmised that the economic activities of a business are balanced when ‘total credits’ are equivalent to ‘total debits’. When errors occur during this accounting method, they are entirely due to the inconsistencies of the debit and credit balance. There are numerous double entry accounting systems including single entry accounting, income accounting, cash accounting, perpetual inventory, and business accounting. However, the major drawback of the double entry accounting method is the overwhelming inclusion of errors. Furthermore, such errors contribute to the tedious cycle of detection, identification, and rectification. Thus, the root cause of the errors is often the inadequate training of the accounting staff, ill-designed accounting software, and poor control over accounting operations.

A double entry accounting system is an accounting system that allows for the recording of both debits and credits using two entry methods. The result is that the system creates a balance on the recording of each and every debit and credit. Generally, a double entry accounting system includes a loan account, an investment account, a revenue account, and an expense account. This allows for the assessment of capital gains, losses, and other transactions related to loans and investments. It is imperative for a new business to use a double entry accounting system in order to keep track of their expenses, revenue, and capital. However, the most common mistake that companies make is to disregard the need for a cost report in their accounting systems. A cost report can show a company’s revenue by breaking it down into specific categories of business expenses.

5. Conclusion: Embracing Double Entry Accounting for Financial Success

A research project involving an assessment of accounting information systems in a third world country culminated in the assessment of how double entry accounting is being utilized in the private sector in that country. Despite the emphasis placed on the importance of double entry accounting by accounting authors, the level of the importance of double entry accounting appeared to be sorely underestimated by accountants practicing in both industry and academia in this African country so this limited survey was conducted in 2014. There were attempts to determine the literacy, adoption, and implementation levels of double entry accounting by such businesses. The responses were shocking as only one organization in the entire survey group claimed to utilize double entry accounting as the method of choice.

The implementation of double-entry bookkeeping made a difference of incalculable significance because it provided a major foundation for the birth of capitalism. Its property lay in a proper distinction between liability and equity [products]. But how is it possible that double entry bookkeeping had consequences of such magnitude? Double entry bookkeeping was a very important foundation of the growth of capitalism once people perceived its meaning and developed, beginning with Luca Pacioli’s time in 1494, as commodity-capital. The significance of double entry accounting is found in what it offers to business managers and the framework it provides for facilitating superior strategic decisions to drive organizations towards scalable impact, profitability, and financial success. Double entry accounting enhances necessary controls, enables transparency, and sharpens analysis with a view to timely informed strategic decision making, a fundamental underpinning for sound organizational practice and enduring financial success, essentials for enterprise survival and dominance.