Seeing Twice: Double Entry Accounting

Double-entry accounting is a method of accounting in which every financial transaction is recorded in at least two different accounts. This system helps to ensure the accuracy and integrity of the financial records by creating a balance between debits and credits. The double-entry system is based on the accounting equation, which states that assets equal liabilities plus equity. This means that every time an asset account is increased, a corresponding liability or equity account must also be increased.

Single Compared to Double Entry

Double-entry accounting and single-entry accounting are two different methods of recording financial transactions.

Double-entry accounting is a method in which every financial transaction is recorded in at least two different accounts. This system helps to ensure the accuracy and integrity of the financial records by creating a balance between debits and credits. The double-entry system is based on the accounting equation, which states that assets equal liabilities plus equity. This means that every time an asset account is increased, a corresponding liability or equity account must also be increased.

Single-entry accounting, on the other hand, is a method in which each financial transaction is recorded only once, usually in a cash or a general journal. This method does not provide the same level of accuracy and integrity as double-entry accounting, since it does not create a balance between debits and credits. As a result, it is more susceptible to errors and omissions.

Double-entry accounting is considered to be a more comprehensive and accurate method of accounting, while single-entry accounting is less formal and more suitable for small businesses or personal finances. Most businesses and organizations use double-entry accounting to keep track of their financial transactions, while single-entry accounting is not widely used in the professional world.

An Example

A company purchases equipment for $5,000 using cash from its checking account. The transaction would be recorded as follows:

Debit: Equipment (Asset account) $5,000 Credit: Checking account (Asset account) $5,000

The debit entry increases the Equipment account by $5,000, and the credit entry decreases the Checking account by $5,000. This ensures that the accounting equation is still in balance, with assets remaining equal to liabilities plus equity. The debit entry increases an asset and the credit entry decrease an asset by the same amount.

Another example can be when a company borrows $10,000 from a bank. The transaction would be recorded as follows:

Debit: Bank loan (Liability account) $10,000 Credit: Cash (Asset account) $10,000

The debit entry increases the Bank loan account by $10,000, and the credit entry increases the Cash account by $10,000. This ensures that the accounting equation is still in balance, with assets remaining equal to liabilities plus equity.

A more complicated example

An example of a double-entry accounting transaction for a purchase using both cash and credit is a company buying inventory for $5,000, paying $2,000 in cash and charging the remaining $3,000 on a credit account. The transaction would be recorded as follows:

Debit: Inventory (Asset account) $5,000 Credit: Cash (Asset account) $2,000 Credit: Accounts payable (Liability account) $3,000

The debit entry increases the Inventory account by $5,000, which represents the value of the goods purchased. The credit entry of $2,000 decreases the Cash account, representing the cash payment made. The credit entry of $3,000 increases the Accounts payable account, representing the amount charged on credit. This ensures that the accounting equation is still in balance, with assets remaining equal to liabilities plus equity.

Depreciation in Double Entry

In double-entry accounting, depreciation is recorded as a gradual reduction in the value of a fixed asset over time. Depreciation is a non-cash expense, meaning it does not involve any outflow of cash. This is why it is recorded as a credit entry to the expense account and a corresponding debit entry to the accumulated depreciation account.

For example, if a company purchases a piece of equipment for $10,000 and estimates that it will have a useful life of five years with a salvage value of $1,000, the annual depreciation expense would be $1,800 ($10,000 - $1,000) / 5 years.

The double entry for the first-year depreciation would be:

Debit: Accumulated Depreciation (Contra-Asset account) $1,800 Credit: Depreciation Expense (Expense account) $1,800

The debit entry increases the Accumulated Depreciation account by $1,800, representing the reduction in the value of the equipment due to wear and tear. The credit entry increases the Depreciation Expense account by $1,800, representing the non-cash expense that reduces the company's net income.

This double entry ensures that the accounting equation is still in balance, with assets remaining equal to liabilities plus equity. The debit entry increases an Contra-Asset account and the credit entry increases an expense account by the same amount.

As the company continues to record depreciation expense each year, the Accumulated Depreciation account will continue to increase, while the value of the fixed asset will decrease correspondingly on the balance sheet.

Recording Depreciation in Single Entry

In single-entry accounting, depreciation is also recorded as a gradual reduction in the value of a fixed asset over time, however, the method of recording it is different from double-entry accounting.

In single-entry accounting, there is no separate account for accumulated depreciation, instead, the original cost of the asset is reduced by the amount of depreciation each year.

For example, if a company purchases a piece of equipment for $10,000 and estimates that it will have a useful life of five years with a salvage value of $1,000, the annual depreciation expense would be $1,800 ($10,000 - $1,000) / 5 years.

In single-entry accounting, the company would record the purchase of the equipment with a debit entry for $10,000 in the fixed asset account. Each year, the company would reduce the value of the equipment by the amount of depreciation expense, by making a credit entry of $1,800 to the fixed asset account, until it reaches the salvage value of $1,000.

Again, Why Double Entry

Double-entry accounting has several advantages over single-entry accounting. One of the main advantages is that it provides a system of checks and balances, as every transaction is recorded in at least two different accounts. This helps to ensure that errors are caught and corrected more easily.

Double-entry accounting also provides a more detailed and accurate picture of a company's financial position. It allows for the preparation of financial statements, such as the balance sheet and income statement, which can be used to analyze the company's performance and make informed decisions.

In addition, double-entry accounting allows for the tracking of the flow of funds, which can be useful for budgeting and forecasting. It also makes it easier to comply with tax laws and regulations, and to produce accurate financial reports for investors and other stakeholders.

Finally, double-entry accounting is more suitable for large and complex organizations, as it can handle a greater volume of transactions and can provide more information about different aspects of the business.