Double-entry accounting is a foundational concept in accounting ensures the accounting equation (Assets = Liabilities + Equity) remains balanced after every transaction. Each transaction affects at least two accounts, one debited and one credit, so the total debits always equal the total credits.
Basic Principles of Double-Entry Accounting
- Debits and Credits: Every transaction involves a debit entry in one account and a corresponding credit entry in another.
- Debit: Left side of an account.
- Credit: Right side of an account.
- Accounting Equation:
- Assets = Liabilities + Equity
- This equation must always be in balance. Double-entry accounting helps maintain this balance.
- Dual Aspect: Every transaction has a dual effect, meaning it affects two accounts.
Example 1: Purchasing Inventory on Credit
Your business purchases $5,000 worth of inventory on credit.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-01-2024 | Inventory/ Purchase A/c Debit | 5,000 | |
| 08-01-2024 | To Accounts Payable A/c | 5,000 |
Explanation:
- Inventory (an asset) will debited because the business now owns more inventory.
- Accounts Payable (a liability) will credited because the business now owes money to the supplier.
Example 2: Paying Salaries
Your business pays $2,000 in salaries to employees.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-02-2024 | Salaries Expense A/c Debit | 2,000 | |
| 08-02-2024 | To Bank A/c | 2,000 |
Explanation:
- Salaries Expense (an expense) will debited because it represents the cost incurred by the business.
- Bank (an asset) will credited because the business has paid out Bank.
Example 3: Selling Goods for Cash
Your business sells goods for $7,000 in cash. The cost of the goods sold was $4,000.
Journal Entry 1 (Recording Sales):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-03-2024 | Cash A/c Debit | 7,000 | |
| 08-03-2024 | To Sales Revenue A/c | 7,000 |
Explanation:
- Cash (an asset) will debited because the business receives cash from the sale.
- Sales Revenue (revenue) will credited because the business earns revenue from the sale.
Journal Entry 2 (Recording Cost of Goods Sold):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-03-2024 | Cost of Goods Sold A/c Debit | 4,000 | |
| 08-03-2024 | To Inventory A/c | 4,000 |
Explanation:
- Cost of Goods Sold (an expense) will debited because it represents the cost incurred to generate revenue.
- Inventory (an asset) will credited because the business’s inventory decreases when the goods are sold.
Example 4: Receiving a Loan
Your business receives a $10,000 loan from a bank.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 08-04-2024 | Bank A/c Debit | 10,000 | |
| 08-04-2024 | To Loan Payable A/c | 10,000 |
Explanation:
- Bank (an asset) will debited because the business now has more cash.
- Loan Payable (a liability) will credited because the business has a new obligation to repay the loan.
Summary
- Double-Entry Accounting ensures every transaction has equal and opposite effects in at least two accounts.
- This method keeps the accounting equation balanced and provides a complete record of financial transactions.
- Every transaction is recorded in at least two accounts: one debit and one credit, ensuring the total debits always equal the total credits.
This system is crucial for accurate financial reporting and is the foundation of modern accounting practices.