A Guide to Double-Entry Accounting (2024)

Journal entries are the building blocks of every company’s accounting system.Bookkeepersrecord financial transactions as journal entries that increase or decrease the amount ofmoney in different accounts, depending on the type of transaction.

With double-entry accounting, each journal entry updates at least two accounts in thecompany’s general ledger, using an equal balance of debits and credits to thoseaccounts.Because each journal entry uses both debits and credits, it is said to have two sides—hence the term “double-entry accounting.”

What Is Double-Entry Accounting (or Bookkeeping)?

Double-entry accounting is a bookkeeping system in whicheach transaction affects at leasttwo accounts and maintains a balance between debits and credits. This approach reduces thelikelihood of accounting errors. Companies of all sizes use double-entry accounting to runtheir businesses.

Double-entry accounting is required for all public companies, and it’s generally anecessityfor businesses that rely on outside financing.

Double-Entry Equation

The accounting equation is a framework that underpins many aspects of businessaccounting, especially double-entry bookkeeping. The accounting equation is:

Assets = Liabilities + Equity

This equation must remain in balance. Double-entry accounting maintains this balance byrecording each transaction as a journal entry that balances an equal number of debits andcredits.

A company’s balance sheet is the embodiment of the accounting equation: It reports thevalueof assets, in balance with its liabilities and equity, at a certain point in time. Theincome statement reflects the changes in a company’s assets, liabilities and equityfrom itsoperations over a given period.

Who Uses Double-Entry Accounting?

Companies of all sizes, across all industries, use double-entry accounting. One key reason isthat it is the only bookkeepingmethodthat complies with U.S. Generally Accepted Accounting Principles (GAAP). All U.S. publiccompanies must be GAAP compliant for financial reporting purposes. Additionally, mostlenders require GAAP-compliant financial statements when evaluating loan applications fromany private or public company.

Double-entry accounting is also the foundation for accrual-basisaccounting. Most companies adhere to this accounting method because it provides amore accurate picture of their financial health.

Key Takeaways

• Double-entry accounting means that each journal entry affects at least two accounts andmaintains a balance between debits and credits.
• Double-entry accounting maintains the accounting equation that assets must equalliabilities plus equity.
• Double-entry accounting is the default system for most businesses because it reduceserrors, enables accrual-basis accounting and is GAAP-compliant.

Double-Entry Accounting Explained

With double-entry accounting, bookkeepers record each financial event with a journal entrythat updates at least two accounts. Bookkeepers choose the appropriate accounts for theseentries from a list of the company’s accounts, called the chart of accounts. The chartofaccounts includes account names and general ledger codes for all classes of accounts on thebalance sheet and income statement. Standard types of accounts include assets, liabilities,equity, revenue and expenses.

Once bookkeepers have selected the right accounts, they create a journal entry, recording thedollar value of the event with a debit or credit in each account. These amounts must beequal and opposite: For example, in a transaction that involves two accounts, the debit toone account must equal the credit to the other account.

In accounting, the terms “debit” and “credit” have a specific meaningthat differs from thecolloquial use of the words (as in “debit cards” or “bank credits”).The way that debits andcredits work depends on the type of account. In accounting, each type of account has anormal or natural balance, which refers to the kind of balance the account is expected tohave and dictates whether debits or credits increase the value in the account. For example,asset accounts have a debit balance, so debits increase them and credits decrease them.Conversely, liabilities have a credit balance; they are increased by credits and decreasedby debits. Each journal entry is shown in two columns in an accounting system, with thedebits on the left and the credits on the right.

The journal entries are posted to the general ledger and periodically “closed” tocreate atrial balance. The closing process includes accumulating all the debits and credits withinan account and offsetting them against each other. The trial balance lists the resulting netdebit or credit value for all the accounts. Like the underlying journal entries, the trialbalance is shown in two columns: debits on the left, credits on the right. The two columnsshould be equal.

After checking the trial balance and making any necessary adjustments, the company creates afinal adjusted balance used to generate the line items in the company’s principalfinancialstatements: the income statement, balance sheet and statement of cash flows.

Double-Entry vs. Single-Entry Accounting

Single-entry accounting is the alternative method to double-entry accounting for recordingfinancial activities. Single-entry accounting resembles a list of transactions in a checkregister or bank statement. Single-entry accounting and double-entry accounting closely mapto whether companies use cash-basis accounting vs.accrual accounting. As the name suggests, with cash-basis accounting, each entryconsists of a debit or credit to a single account.

While single-entry accounting is simpler to implement, it has significant shortcomingscompared with double-entry accounting. It is more prone to errors, especially omissions andduplications, because it lacks the double-entry accounting control method of balancingaccounts.

Additionally, single-entry doesn’t create a complete financial picture of the businessbecause it only records cash inflows and outflows, reflecting when cash is in hand versuswhen it is actually earned. It also doesn’t reflect things like sales made on credit.Finally, it requires extra work in the closing process to yield balanced financialstatements. Public companies can’t use single-entry accounting because it’s notacceptedunder GAAP.

Rules of Double-Entry Accounting

There are two important rules that govern the ways companies use double-entry accounting.These rules ensure that the accounting equation is balanced and reduce the likelihood oferrors:

1. Every transaction must be recorded in two or more accounts.
2. For each transaction, the total amount debited must equal the total amount credited.

While every transaction must be recorded in at least two accounts, the number of accounts onthe left (debit) side of the journal entry does not need to be the same as the number ofaccounts on the right (credit) side. Journal entries with three or more accounts are called“compound entries.” For example, when a loan payment is made, the compound entrydebits twoaccounts: loans payable and interest expense. But it credits only one account: cash.

Additionally, although the debits must equal credits in each transaction, a journal entry maynot result in an increase to one account and a matching decrease to another because of theway natural balances work. If one account has a natural debit balance, a debit will increasethe total amount in the account. If the other account updated in the transaction has anatural credit balance, the corresponding credit will increase that account, too. A singlejournal entry can increase both accounts at the same time, decrease both or a combination.

And finally, it’s important to dispel any misconceptions that debits are good andcredits arebad, or vice versa. It depends on the account and the specific situation. Debits increaseasset accounts, such as the company’s cash account. In most cases, this is consideredapositive. However, debits also increase expenses, which may be viewed as a negative.

How Double-Entry Accounting Works

The process of setting up and using a double-entry accounting system can be divided into fourkey steps. It begins with setting up the accounts in which bookkeepers will recordtransactions and ends with using the account information to generate financial statements.The stages are:

1. Create a chart of accounts, which is a complete listing of all thegeneral ledger accounts a company can use to record transactions. It includes all theaccounts for each of the five types: assets, liabilities, equity, revenue and expense.Most accounting software includes pre-made charts of accounts with room forcustomization, while other accounting solutions allow for customized charts of accounts.
2. Use debits and credits for all transactions in equal amounts to reflectthe substance of a transaction. Debits and credits can be in any monetary unit.
3. Make sure every transaction has two components (debits and credits, inbalance) in accordance with the accounting equation. Accounting software oftenfacilitates this.
4. Run financial statements straight out of the double-entry accountingsystem. When closing the books at the end of each accounting period, the net accounttotals in the double-entry accounting system are used to create the company’strial andfinal balance. The final adjusted balances flow into financial statement line items.Accounting software can automate the integration and process flow necessary to do this.

History of Double-Entry Bookkeeping

Double-entry bookkeeping has an interesting history. Some historians credit the Italianmathematician Luca Pacioli, known as the father of accounting, with inventing thedouble-entry system in the 1400s. Others suggest that double-entry accounting was being usedin Korea centuries earlier or point to the ancient Romans who used a similar system.

Regardless of which version of history is most accurate, double-entry accounting has beenaround for a long time and is the bedrock on which accounting rests.

Types of Accounts

In double-entry accounting, businesses can use any combination of the five types of accounts— assets, liabilities, equity, revenue, expense, gains and losses — whenrecordingtransactions. Each journal entry has two sides, with debits on the left and credits on theright. The type of account dictates whether it has a normal debit balance or a normal creditbalance, and therefore whether debits or credits increase the balance.

The five types of accounts are:

• Assets: Resources owned by a company that represent future economicvalue. Examples of asset accounts include cash, accounts receivable and equipment.Assets have a normal debit balance and are increased via debits.
• Liabilities: Amounts owed or committed by a company. Examples includeaccounts payable, loans and accrued expenses. Liabilities have a normal credit balanceand are increased via credits.
• Equity: Amount of funds invested in a business by its owners plus allretained income from operations. Examples include paid-in equity (funds from investors),retained earnings and common stock. Equity has a normal credit balance and is increasedvia credits.
• Revenue: Money generated from any operating activities. Examplesinclude product sales, service fees and interest income. Revenue has a normal creditbalance and is increased via credits.
• Expenses: Costs incurred in running a business. Examples of expenses includeinventory purchases, salaries and depreciation. Expenses have a normal debit balance andare increased via debits.

The following chart summarizes the impact of debits and credits for each of the five types ofaccounts.

Double-Entry Accounting System

In practice, using a double-entry accounting system quickly becomes second nature.Bookkeepers become fluent in the language very quickly and begin to think in terms of T-accounts, which are visual representations of accounts listing debits on the left andcredits on the right. The graphic above is set up to resemble a T-account.

Like idioms in language, certain account pairings are ingrained in the double-entryaccounting system. For example, transactions often debit accounts receivable and creditsales, or they debit cash and credit accounts receivable.

Double-Entry Accounting Examples

Let’s explore some real-world examples of double-entry accounting for common businesstransactions. Each scenario uses a typical journal entry style that lists the account names,debits on the left, credits on the right and a memo below.

This journal entry puts the tractor on the books, increasing the balance in the asset accountwith a debit representing its value and reducing the balance in the cash account with acredit.

This entry increases the inventory asset account with a debit and establishes a liability forthe amount owed on credit with a credit. When the company pays the bill from Checkers SugarSupply, the bookkeeper will reduce accounts payable with adebit and reduce cash with a credit.

This entry puts an account receivable onthe books by debiting the asset and records revenue earned with a credit. Both sides of theentry increase the respective accounts.

How to Use Double-Entry Accounting

As the example above shows, double-entry accounting needs to be well-organized in order toaccurately record the full impact of the company’s transactions and reflect thatimpact inits financial statements. As the volume of transactions increases, this becomes moredifficult.

As a result, few companies today use manual recording methods for double-entry bookkeeping.At a minimum, modern bookkeeping relies on spreadsheets that can automate some calculations.Most often, companies use accounting software to simplify and automate the process andprevent errors that lead to inaccurate financial statements and other issues.

How to Decide Whether Double-Entry Is Right for My Business

Double-entry accounting is the default approach for most businesses because of the need togenerate GAAP-compliant financial statements for owners and lenders. Public companies arerequired to use double-entry accounting to meet GAAP requirements. But some owners ofrelatively simple private businesses may have to decide whether to use double-entry orsingle-entry accounting. Questions that can help owners decide include:

• Does the business own or hold inventory?
• Does the business have multiple employees?
• Does the business have a robust chart of accounts?
• Does the business owe money to people outside the company or plan to apply for loans?
• Does the company plan to use an automated accounting system?

If the answer is yes to any of the above, double-entry accounting is likely the best approachfor your business. Double-entry accounting most appropriately handles balance sheet accountsthat are typically required for activities like holding inventory, paying employees andcomplying with loan agreements. Well-designed user interfaces can simplify double-entryaccounting for companies that have a long list of general ledger accounts.

Double-Entry and Accounting Software

Gone are the days of leather-bound ledgers kept in a safe. Businesses of every size maintaintheir books using accounting software designed for double-entry accounting. Even smallbusinesses can benefit from the time savings and accuracy that leading accounting solutions bring,especially as they grow. Some systems simplify data entry by tracking digital receipts andallowing users to upload photos of physical ones, a much better alternative to keepingshoeboxes full of paper documentation. Accounting software can also typically integrate withbank and credit card accounts to automatically pull in information from those sources. Andfor business owners who use tax professionals, uploading data to tax systems when it comestime to file tax returns is much easier and less time-consuming than manual methods for bothparties.

Larger businesses have taken advantage of double-entry accounting software for decades. It isa necessity given the complexity and volume of their business. When choosing accountingsoftware, companies should look for features such as real-time data access, advancedanalytics tools and accelerated closing processes.

Double-entry accounting is the foundation of financial management at most businesses. Ithelps growing businesses track increasingly complex operations, and it’s essential forpublic companies and for private ones that rely on outside financing. Software can automateand greatly simplify the process of establishing and maintaining a double-entry accountingmethod and using it to generate financial statements.

Double-Entry Accounting FAQs

What is meant by double-entry accounting?

Double-entry accounting is a method for booking journal entries to reflect financial activityby updating two or more accounts with equal and opposite debits and credits.

What are the two rules of double-entry accounting?

The two rules of this type of accounting are every transaction must be recorded in two ormore accounts, and the total amount debited needs to equal the total amount credited. Theserules keep the accounting equation in balance.

What is the double-entry system with an example?

Below is an example of double-entry accounting for buying a piece of equipment in cash. Thejournal entry puts the van on the books by increasing the balance in the asset account. Itreduces the balance in the cash account with a credit for the same amount.

Is double-entry accounting necessary?

It depends on the business, but many require double-entry accounting. This system isnecessary for any business that needs to generate GAAP-compliant financial statements forowners or lenders, which includes public companies. Smaller businesses that operate using cash-basis accountingmay find single-entry bookkeeping is simpler and adequate for their needs.