4.26: Double Entry Bookkeeping System
Learning Outcomes
- Describe the double entry bookkeeping system
Double-Entry Bookkeeping
Double-entry bookkeeping, in accounting, is a system of bookkeeping so named because 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. For instance, recording a sale of $100 might require two entries: a debit of $100 to an account named “Cash” and a credit of $100 to an account named “Revenue.”
Debits and Credits, Left and Right
You may hear accountants talk in terms of debits and credits. Debit literally means left, and credit means right. Accountants use a two-column journal to record transactions, so the above bonus would be recorded like this in 2017:
| Account | Debit | Credit |
|---|---|---|
| Bonus (expense) | 5,000 | |
| Accrued Bonus (liability) | 5,000 |
In this entry, the bonus is recognized before the cash payment to the salesperson actually occurs, along with a liability in the same amount. In the following month, when the company pays the bonus, it would record the following entry:
| Account | Debit | Credit |
|---|---|---|
| Accrued Bonus (liability) | 5,000 | |
| Checking Account (asset) | 5,000 |
The cash balance declines as a result of paying the commission, which also eliminates the liability. The reason your debit card is called a debit card is because the bank shows your balance as a liability because they owe your money to you—in essence, they are just holding it for you. A liability usually has a credit balance (balance on the right side of the ledger) and so when you spend money and they pay it out on your account, they debit your account (a debit offsets a credit.) The figure below illustrates how debits and credit affect various types of accounts.
The Accounting Cycle
The accounting cycle begins with transactions and ends with completed financial statements. The first step is to journalize the transaction. The journal is a chronological list of each accounting transaction and includes at a minimum the date, the accounts affected, and the amounts to be debited and credited.
Periodically, depending on the business, journal entries are posted to the general ledger. The general ledger is the exact same information as the journal, but sorted by account.
Once all journal entries are posted, the ledger balances are posted to a trial balance, which is a list of all the accounts and balances, checking to see that the total of the debit column is equal to the total of the credit column. Each account is then checked for accuracy and adjusted, if need be, before the financial statements are run. This process is referred to as the “Accounting Cycle.”
There are no debits or credits on the financial statements—they are informational reports, not data, so they are built with the user in mind
Summary
The double-entry bookkeeping system is summarized below:
- Assets. Items of financial value that the business controls (“owns”) for the purpose of producing income for the owners.
- Liabilities. Monies that the business owes to non-owners.
- Owners Equity. The theoretical value of the business that would be distributed to the owners after the assets were sold and the liabilities paid.
- Revenue. Payments made to the business by customers for the goods and/or services provided by the business.
- Expenses. Costs incurred by the business in providing the goods and/or services purchased by the customers.
Practice questions