Double entry bookkeeping is a system of accounting that has been
in use for centuries, and it is still widely used today. It is a method of
recording financial transactions in which every transaction is recorded in two
different accounts: one account is credited, and the other account is debited.
This system of accounting is essential for businesses and organizations because
it ensures that financial records are accurate and complete.
Double entry bookkeeping and Accounting are important for
accuracy and are recommended by both GAAP and IFRS. Every business transaction
has two aspects we consider when we pay cash against salaries it
affects both accounts as per accounting and bookkeeping rules the cash decrease
and salary expense increase, double entry bookkeeping record for both
aspects of the transaction. Double entry bookkeeping and accounting records for both
aspects of the transaction. Double entry bookkeeping provides a detailed view
of a business's financial health and accurate information about the business's
financial health.
What is double entry bookkeeping?
Evert financial
transaction has two aspects and respectively hits two accounts. There is a
debit and credit concept in accounting which is then applied. You have to debit
one account and credit the other one. If you are wondering what debit and
credit and what account should be debited and what should be credited here is the
explanation to it for all classes of financial transactions.
Importance of double entry bookkeeping
One of the main advantages of double entry bookkeeping is that it helps to
prevent errors and fraud. With this system, every transaction must be recorded
in two different accounts, which means that any discrepancies or errors will be
immediately apparent. This makes it much more difficult for fraudsters to
manipulate the financial records of a business or organization.
Another advantage of
double entry bookkeeping is that it provides a clear and comprehensive picture
of a business's financial health. By recording every transaction in two
different accounts, this system ensures that all financial information is
organized and easy to understand. This makes it much easier for business
owners, managers, and investors to make informed decisions about the company's
future.
In addition, double
entry bookkeeping is also important for tax and regulatory compliance. By
maintaining accurate financial records, businesses can ensure that they are
complying with all relevant laws and regulations. This can help to avoid costly
fines and legal penalties, as well as protect the reputation of the business.
Double entry or credit/debit for Assets
For assets is the asset
increases it becomes debit and if it decreases it becomes credit.
Double entry or credit/debit for Liabilities
If liability increases,
it becomes a credit and if liability decreases it becomes a debit.
Double entry or credit/debit for Income
When income increases or
is earned it becomes credit and vice versa
Double entry or credit/debit for Expenses
Expenses when increased
become debit and vice versa.
Example
Consider you have
purchased the machinery for $1000 dollars and you paid 40% and 60% is payable
after a month, and using this plant you generate 100 units which you sold for
$200 $2 dollar per unit, and your expenses for that week was 20 dollars here is
the double entries for the given scenario:
Before going forward
with the example, we need information about charts of accounts. The chart of
accounts is the list of accounts that your categories transaction into and
appear as a separate line item of financial statement/financial reports is it
profit and loss or balance sheet?
Description |
debit |
credit |
Machinery |
1000 |
|
cash |
400 |
|
Payable |
600 |
|
income |
200 |
|
Misc. expenses |
20 |
The chart of accounts is
the list of accounts that your categories transaction into and appear as
separate line items of financial statement/financial reports are it profit and
loss or balance sheet. Setting up a chart of accounts is a technical task
depending upon the nature and industry in which the business operates.
Here
are charts of accounts
Assets
·
Building
·
Cash
·
Inventory assets
·
Petty cash balance
·
Prepaid insurance
·
Savings funds
·
Undeposited funds
·
Vehicles
Liabilities
·
Accrued liability
·
Notes payable
·
Company credit card balances
·
Payroll
Owner’s equity
·
Common stock
·
Preferred stock
·
Retained earnings (accounts associated with the owner’s equity)
·
Revenue
·
Expenses
There is a famous
equation in double entry bookkeeping that the sum of equity and liability must
be equal to assets which is termed the accounting equation. Double-entry
bookkeeping must follow this equation: Assets = Liabilities +
Equity.
Assets include
·
Property plant and equipment
·
Cash
·
Cash equivalents
·
certificates of deposit or Treasury bills (Liquid asset)
·
Inventory
·
Account receivable
·
Short-term investment (cash equivalent)
Liabilities include
·
Debt
·
Dividends payable
·
Long-term debt
Equity is the amount
that shareholders contribute initially plus/minus any retained earnings. This
can also be explained as equity is the amount available to be distributed among
shareholders after all assets are liquated and debts or liabilities are paid.
The
retained earning refers to in the second last paragraph is the percentage of
earnings that is kept under the equity section of the balance sheet and is held
and not yet paid to shareholders. Retained earnings may be positive or
negative. Positive retained earnings are the accumulation of profit over the
periods and negative retained earnings are the accumulation of losses over the
years doing your own bookkeeping is a time-consuming cost and it may result in
inaccuracies.
Partner
with professional bookkeepers
that understand every aspect of bookkeeping from double entry bookkeeping to
taxation. It helps you avoid tax audits and penalties and make an informed decision and has an accurate set of financial statements.