Are you having a hard time in trying to fathom double-entry accounting work for your brand new business venture?
Well, don’t get worked up so easily, for we have got you covered.
In this article, let us try to trace some of the rules associated with double-entry accounting, and the various advantages of the same.
Double-entry accounting entails that for every financial transaction that occurs, corresponding entries must be made into two or more accounts – a debit account and a credit account. Along with this, the double-entry system also implies that the amount of debits and credits remains the same.
What is double entry accounting system?
In the double-entry system, any transaction is either labelled as a debit item or a credit item. Any effect in one account will have an equal and opposite effect on the other account. If one debit item is entered in to one account, a credit item of the same amount is entered into the other account. In the end, this ensures that both the accounts are balanced, thus providing the correct assessment of the owner’s business finances. With the double-entry accounting system, it becomes easier for owners to prepare business statements as and when required.
There are four different types of accounts that are associated with double-entry accounting:
- Asset accounts: This shows finances related to elements owned by a business. For example, warehouses, or cash capital form a part of asset accounts.
- Liability accounts: These are the opposite of asset accounts- this means that it records debts that a business may owe to the bank or any other lender. A mortgage, for example, would be an expense you add to your liability account.
- Income account: For any individual, the income account would note all the money that the business receives.
- Expenses account: Similarly, expenses accounts record the expenses associated with a business.
Some examples of double-entry accounting
Double-entry accounting can be understood better with the help of certain examples:
- Suppose you add a certain amount of money to one of your accounting books. With the addition of the credit amount, you will also have to add the same amount to the other account- in order to balance out the two accounts.
- When you acquire an asset, for example, a warehouse for your business, your debit amount increases. However, this must be matched with an equal entry into the credit column, to make up for the decreased credit.
- Again, when you borrow money, your credit account will be affected, so there will be an addition to the credit account. However, in paying off the debt, your monthly expenses will change as well, which you will have to add to your debit or expenses account. The resultant amount on both accounts should be the same.
What are the rules of double-entry accounting?
Here, we will take a look at some of the rules that need to be followed with double-entry accounting-
- In double-entry accounting, essentially money is transferred from one account to another. ‘Debit’ refers to when money is being transferred to an account, and ‘credit’ refers to when money is being transferred from an account. So, when you spend some money on any object, you will have to transfer that money from your credit account to your debit account.
- Basically, your transactions need to have a source and a destination. If the transaction originates in the credit account, it should be destined to the debit account, and vice versa.
- Usually, the left column is labelled as the debit column, and the right one is labelled as the credit account. It is not mandatory for you to follow these labels- you can label them as and how you like.
- The sum total on both accounts has to be the same.
- The following accounting equation can be used to calculate assets:
Assets = Liabilities + Equity
This equation is helpful, since if the total assets do not match the corresponding total of liabilities, then it should be clear that an error has occurred somewhere in the entries.
It should be remembered that double accounting can involve more than two accounts. In any case, the basic principle remains the same- the total of all the accounts should be the same.
Advantages of double accounting system
There are plenty of advantages of double accounting:
- It reveals errors in accounting
This is the primary advantage of double accounting. Since double accounting calls for the balance of the different sum totals, any imbalance would reveal a mistake in data entry. It can also be used to reveal exactly where the mistake has been made, for ease of rectification.
- It provides accurate financial statements
The principle of double accounting is based on balance. The calculations required to balance out the two accounts ensure that the statements delivered at the end are accurate and free of errors.
- It can be used to analyses financial activity
With the debit and credit columns in place, owners can easily take a look at the records of their financial activity. This becomes extremely important when developing financial reports, and lends to the accuracy of the same.
- It can help save time and money
With double-entry accounting, owners can save a lot of time and money which would have been wasted in tracking records of debit amounts and credit amounts separately. Also, the use of double-entry accounting software will also help owners save on major corporate costs.
- It is the common language spoken by chartered accountants
Any chartered accountant would be familiar with the concept of double-entry accounting. So, when you employ a certain CA to look into your finances, they would easily be able to understand and examine the situation at hand and get on board with your financial condition.
What is the best software for double-entry accounting?
Nowadays, all financial procedures have become digitised, double-entry accounting is no different. Accounting software like Freshbooks include features that provide the provision for double-entry accounting.
Freshbooks is the go-to software for all your accounting needs, and with the addition of the double-entry bookkeeping feature, it has become bigger and better than before.
Double-entry accounting is usually associated with bigger businesses. Individual freelancers managing their accounts do not resort to double-entry accounting. For them, the primary tracking and invoicing options of Freshbooks are deemed sufficient. However, if the individual wants to analyse their business’s economic development in order to create an effective financial report, then Freshbook’s double-entry accounting tools will come in handy.
Freshbooks’ double-entry accounting style provides you with almost everything you need at one stop. It’s a boon for both you and your chartered accountant- they receive all the financial information about your business at once, and you will have access to statistics such as how your business is performing in the current economic system, and how much growth you can expect in the near future.
If you’re the proud owner of a small business venture, Freshbooks has something for you as well. With the help of the double-entry accounting features, you can gain deeper insight into your business’s financial performance, and how it has grown from the past to the present. Similarly, you can develop an idea as to how your business may grow in the near future. When your accounts are developed in the standard industry format, it will be easier for you to provide your accountant with the necessary information during tax time.
Some of the double-entry accounting features provided by Freshbooks
Freshbooks has about eight features that form its double-entry accounting system:
- Cost of Goods Sold: the sum total products and services that your business has sold to your client will be recorded here.
- Other income: any income that you receive outside what is being recorded by Freshbooks will be added to this account.
- Trial balance: with trial balance, you will receive a rough sum total of your debit amounts and credit amounts. Any discrepancy between the two accounts will reveal errors in entry.
- Chart of accounts: all the accounts that record any business transactions will be listed in the same place. This will help ensure that all your tax information is readily available to your accountant during tax time.
- Accountant access: Specialized access for your accountant will ensure that they can take a look at your account books and work out any glitches that may have worked up.
- Bank reconciliation: if you forget to add any entries of accounts (obviously ones that occur outside your Freshbooks entries),
- Balance sheet: this provides you with a full total of all your finances in the same place.
Double-entry accounting is an effective bookkeeping system that ensures that your debit amount and your credit amount is the same. It is widely used due to its accuracy, and with accounting software such as Freshbooks, this is made even more prominent. It is perfect for both small and large businesses and is industrially accepted as the standard.