Double Entry System of Book-Keeping

23/12/2020 1 By indiafreenotes

Double-entry bookkeeping, in accounting, is a system of book keeping where every entry to an account requires a corresponding and opposite entry to a different account. The double-entry has two equal and corresponding sides known as debit and credit. The left-hand side is debit and right-hand side is credit. In a normally debited account, such as an asset account or an expense account, a debit increases the total quantity of money or financial value, and a credit decreases the amount or value. On the other hand, for an account that is normally credited, such as a liability account or a revenue account, it is credits that increase the account’s value and debits that decrease it.

In double-entry bookkeeping, a transaction always affects at least two accounts, always includes at least one debit and one credit, and always has total debits and total credits that are equal. This is to keep the accounting equation (below) in balance. For example, if a business takes out a bank loan for Rs. 10,000, recording the transaction would require a debit of Rs 10,000 to an asset account called “Cash”, as well as a credit of Rs. 10,000 to a liability account called “Notes Payable”.

Assets = Liabilities + Equity

The accounting equation is an error detection tool; if at any point the sum of debits for all accounts does not equal the corresponding sum of credits for all accounts, an error has occurred. However, satisfying the equation does not guarantee that there are no errors; the ledger may still “balance” even if the wrong ledger accounts have been debited or credited.

Accounting entries

In the double-entry accounting system, at least two accounting entries are required to record each financial transaction. These entries may occur in asset, liability, equity, expense, or revenue accounts. Recording of a debit amount to one or more accounts and an equal credit amount to one or more accounts results in total debits being equal to total credits when considering all accounts in the general ledger. If the accounting entries are recorded without error, the aggregate balance of all accounts having Debit balances will be equal to the aggregate balance of all accounts having Credit balances. Accounting entries that debit and credit related accounts typically include the same date and identifying code in both accounts, so that in case of error, each debit and credit can be traced back to a journal and transaction source document, thus preserving an audit trail. The accounting entries are recorded in the “Books of Accounts”. Regardless of which accounts and how many are involved by a given transaction, the fundamental accounting equation of assets equal liabilities plus equity will hold.

Traditional approach

Following the Traditional Approach (also called the British Approach) accounts are classified as real, personal, and nominal accounts. Real accounts are accounts relating to assets and liabilities including the capital account of the owners. Personal accounts are accounts relating to persons or organisations with whom the business has transactions and will mainly consist of accounts of debtors and creditors. Nominal accounts are revenue, expenses, gains, and losses. Transactions are entered in the books of accounts by applying the following golden rules of accounting:

  • Real account: Debit what comes in and credit what goes out.
  • Personal account: Debit the receiver and credit the giver.
  • Nominal account: Debit all expenses & losses and credit all incomes & gains

Accounting equation approach

This approach is also called the American approach. Under this approach transactions are recorded based on the accounting equation, i.e., Assets = Liabilities + Capital. The accounting equation is a statement of equality between the debits and the credits. The rules of debit and credit depend on the nature of an account. For the purpose of the accounting equation approach, all the accounts are classified into the following five types: assets, capital, liabilities, revenues/incomes, or expenses/losses.

If there is an increase or decrease in a set of accounts, there will be equal decrease or increase in another set of accounts. Accordingly, the following rules of debit and credit hold for the various categories of accounts:

  • Assets Accounts: debit entry represents an increase in assets and a credit entry represents a decrease in assets.
  • Capital Account: credit entry represents an increase in capital and a debit entry represents a decrease in capital.
  • Liabilities Accounts: credit entry represents an increase in liabilities and a debit entry represents a decrease in liabilities.
  • Revenues or Incomes Accounts: credit entry represents an increase in incomes and gains, and debit entry represents a decrease in incomes and gains.
  • Expenses or Losses Accounts: debit entry represents an increase in expenses and losses, and credit entry represents a decrease in expenses and losses.

Types of Accounts

The accounting and book-keeping process measures, records and communicates day to day financial activities. A transaction is an event taking place between two economic entities, such as customers or vendors and businesses. Accounting and book-keeping record this event.

Under a systematic accounting process, the activities are recorded into various accounts to keep the data bifurcated and classified under account heads. There are majorly seven types of accounts wherein all the business accounting entries and transactions are classified. These are:

  • Assets
  • Liabilities
  • Equity
  • Gains
  • Losses
  • Expenses
  • Revenues

The accounting and book-keeping is a continuous process of tracking changes in each account as the company continues to do its operations.

Debit and Credit

Debits and Credits are essentials to enter data in a double entry system of accounting and book-keeping. While posting an accounting entry, an entry on the left side of the account ledger is a debit entry and right-side entry is a credit entry.

Advantages of Double Entry System

  • This system increases the Accuracy of the accounting, through the trial balance device
  • Profit and loss suffered during the Year can be calculated with details
  • By following this system, the company can keep the accounting records in detail which eventually helps in controlling
  • The recorded details can be used for comparison purpose as well. Details of the first year can be compared with the second year, deviations found any during comparison can be worked on.

Features of Double Entry Accounting system

  • A transaction has two-fold aspects i.e., one giving the benefit and the other receiving the benefit.
  • A transaction is divided into two aspects, Debit and Credit. One account needs to be debited and the other is to be credited.
  • Every debit must have its corresponding and equal credit.

Advantages of Double Entry Accounting system

  • As both the personal and impersonal accounts are maintained under the double entry system, both the effects of the transactions are recorded.
  • It assures arithmetical accuracy of the books of accounts, for every debit, there is a corresponding and equal credit. This is arrived by preparing a trial balance periodically or at the end of the financial year.
  • Prevents and minimizes frauds. Frauds can be even detected early.
  • Errors can be checked and rectified easily.
  • The outstanding balances of receivables and payables are determined easily since the personal accounts are maintained.
  • Businesses can compare the financial position of the current year with that of the past year/s.
  • Helps to justify the standing of business on the valuation date in comparison with the previous years’ purchase, sales, and stocks, incomes and expenses with that of the current year figures.
  • The calculated net operating results can be ascertained by preparing the trading and profit and loss A/c for the year ended and the financial position can be ascertained by the preparation of the balance sheet.
  • Government can easily decide on the tax to be calculated on the businesses net earnings.
  • Outsiders and stakeholders like suppliers, banks, holders of equity etc take a proper decision regarding grant of credit or loans or subscribing for the shares.

Books of accounts

Each financial transaction is recorded in at least two different nominal ledger accounts within the financial accounting system, so that the total debits equals the total credits in the general ledger, i.e., the accounts balance. This is a partial check that each and every transaction has been correctly recorded. The transaction is recorded as a “debit entry” (Dr) in one account, and a “credit entry” (Cr) in a second account. The debit entry will be recorded on the debit side (left-hand side) of a general ledger account, and the credit entry will be recorded on the credit side (right-hand side) of a general ledger account. If the total of the entries on the debit side of one account is greater than the total on the credit side of the same nominal account, that account is said to have a debit balance.

Double entry is used only in nominal ledgers. It is not used in daybooks (journals), which normally do not form part of the nominal ledger system. The information from the daybooks will be used in the nominal ledger and it is the nominal ledgers that will ensure the integrity of the resulting financial information created from the daybooks.

The reason for this is to limit the number of entries in the nominal ledger: entries in the daybooks can be totalled before they are entered in the nominal ledger. If there are only a relatively small number of transactions it may be simpler instead to treat the daybooks as an integral part of the nominal ledger and thus of the double-entry system.

However, as can be seen from the examples of daybooks shown below, it is still necessary to check, within each daybook, that the postings from the daybook balance.

The double entry system uses nominal ledger accounts. From these nominal ledger accounts a trial balance can be created. The trial balance lists all the nominal ledger account balances. The list is split into two columns, with debit balances placed in the left-hand column and credit balances placed in the right-hand column. Another column will contain the name of the nominal ledger account describing what each value is for. The total of the debit column must equal the total of the credit column.

Debits and credits

Double-entry bookkeeping is governed by the accounting equation. If revenue equals expenses, the following (basic) equation must be true:

Assets = liabilities + equity

For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are made by debits and credits to the accounts. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the normal balance of the account. Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal balance of debit. Liability, Revenue, and Capital accounts (on the right side of the equation) have a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in each day’s transactions must equal the sum of all credits in those transactions. After a series of transactions, therefore, the sum of all the accounts with a debit balance will equal the sum of all the accounts with a credit balance.

Debits and credits are numbers recorded as follows:

  • Debits are recorded on the left side of a ledger account, a.k.a. T account. Debits increase balances in asset accounts and expense accounts and decrease balances in liability accounts, revenue accounts, and capital accounts.
  • Credits are recorded on the right side of a T account in a ledger. Credits increase balances in liability accounts, revenue accounts, and capital accounts, and decrease balances in asset accounts and expense accounts.
  • Debit accounts are asset and expense accounts that usually have debit balances, i.e. the total debits usually exceed the total credits in each debit account.
  • Credit accounts are revenue (income, gains) accounts and liability accounts that usually have credit balances.
  Debit Credit
Asset Increase Decrease
Liability Decrease Increase
Income (revenue) Decrease Increase
Expense Increase Decrease
Capital Decrease Increase