What is Double Entry Accounting System?
The double entry accounting system, also known as bookkeeping is defined as a business transaction that involves two accounts or more. This transaction happens when a company or a business borrows money from its own bank, the company’s cash amount will increase and so does its liability account loans payable. Another example is when a company pays a $200 for a media advertisement, its Cash account will decrease while its advertising expense account will increase.
A Double entry accounting also allows for the accounting equation, which is assets = liabilities + owner’s equity, to be an inconsistent balance. From our example above with the advertising expense, the accounting equation remained in balance because expenses cause owner’s equity was decreased.
Without applying a double entry accounting system concept, accounting records would only show a partial view of all the company’s affairs, which is crucial. Imagine if a business purchased a machine during a year, but the accounting records do not show whether the machine was purchased for cash or on credit. Perhaps the machine was bought in exchange for another machine. This information would only be available if you have applied double entry accounting system.
The two effects of an accounting entry are known as Debit (Dr) and Credit (Cr). The accounting system is based on the principle that for every Debit entry, there will always be an equal Credit entry. This is also known as the Duality Principal.
The Debit entries are ones that account for the following effects:
- Increase in assets
- Increase in expense
- Decrease in liability
- Decrease in equity
- Decrease in income
Credit entries are ones that account for the following effects:
- Decrease in assets
- Decrease in expense
- Increase in liability
- Increase in equity
- Increase in income
The Double Entry accounting system is recorded in a manner that the Accounting Equation is always in balance.
Assets – Liabilities = Capital
Any increase in expense (Dr) will be offset by a decrease in assets (Cr) or an increase in liability or equity (Cr) and vice-versa. Hence, the accounting equation will still be in equilibrium.
Examples of Double Entry Accounting System
Now that you’ve understood the basics of the double entry accounting system, here are double entry accounting examples to understand more this accounting transaction.
Example # 1
Christine bought a center table for her living room up at $2,000. She paid $1,000 in advance and $1,000 was due upon delivery after the table was ready. Here is how the entries should be posted in the Double entry system on that date.
To: Furniture A/c $2,000 Dr.
By: Cash $ 1,000 Cr.
By: Accounts Payable $ 1,000 Cr.
In this case, although 3 accounts were given effect, the net entry between debit and credit is “0”. Hence, it suggests that every debit should have a corresponding credit, whether the transaction is realized or not, in order that totally gets nullified. On the date when Christine bought the center table, she had paid only $1,000. Even if the rest of the amount is not actually paid on this day, it becomes accrued in Accounts Payable A/. Once the amount is paid after delivery of the table, this will be the effect:
To: Accounts Payable A/c $1,000 Dr
By: Cash $ 1,000 Cr.
Example # 2
Another example is a company’s payment of utility bills.
Debit: Utility expense – Increase in expense
Credit: Cash – Decrease in Asset.
Example # 3
Angelo purchased an Apple MacBook worth $5,000. He paid cash for the same from all the savings he had made for this. The financial entries for this date should be:
To: Apple MacBook A/c $5000 Dr.
By: Cash $ 5000 Cr.
Example # 4
A company (let’s call it “X”) provides gadget repair services. They offer services on the advance part-payment policy. A customer walked into their shop for services, paid $500 in the beginning, and once his smartphone got repaired, he paid $500 upon delivery. In this case, these will be the entries on the first day:
To: Cash $500 Dr.
To: Account Receivable A/c $500 Dr.
By: Service Revenue $1,000 Cr.
On the delivery date, these will be the entries in the company’s system:
To: Cash $500 Dr.
By: Account Receivable A/c $500 Dr.
If we take a net effect for both these days only in the accounting system, we see that Cash A/c holds $1,000 debit and Service Revenue holds $1,000 credit which again nets off the total amount.
The advantages of a Double Entry Accounting System
Using Double Entry accounting system have also advantaged for the business or a company. Below are the following:
- This system of accounting brings standardization across all the industries and companies that use it.
- Double Entry System is helpful in the overall reporting structure.
- Company analysis becomes easier to handle since the parameters and entries can be decoded by anyone.
- Double entry system of accounting is also easy to understand and predictable. With each entry, double entry system of accounting becomes easy to identify what type of transaction had taken place.
- Auditing task is made simpler.
- All similar type of chart of accounts can be put together, and thus profit and loss statement can be made easier.
- If the assets and liabilities entries do not match, errors can be easily spotted, and with the existence of a proper chart of accounts and ledger, missing or incorrect entries can be sorted out.
The disadvantages of Double Entry Accounting System
If the accounting terms and entries been using different mode or if it was not standardized, below would result to such disadvantages:
- Individual accounting terms and entries may create the huge list of the chart of accounts. Tallying and comparing with those used by others for further analysis would have been stressful and not mention, very time-consuming.
- It creates confusion and the possibility of multiple entries which may result in an incorrect balance.
- The equality between assets and liabilities serves like a check for matching all types of transactions. If this check is not present, the troubles in the system of accounting can be estimated.