Understanding the Double Entry Accounting System

Accounting
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Fincent Team

Starting your own creative business might sound like a lot of fun. However, as you get into its intricacies, it can often become increasingly complicated. Starting a new business can be both exciting and intimidating at the same time.

You will be the one running the show once you start your own business. The ownership of any entity comes with several responsibilities like setting up the website, finding the right vendors, filing your taxes, etc. The burden of handling all these aspects of a business can leave you overwhelmed.

However, with adequate planning and agenda-setting in place, you can manage your business quite well. Multiple corporations specialize in functions like designing, marketing, etc. Accounting basics is one such function that you can outsource to take a part of the burden off your shoulders.

Accounting is a multi-faceted discipline that involves bookkeeping as well as analysis of various financial statements. As a business owner, you can choose to focus on the ideation of business offerings and hire an accountant to take care of its finances.

As soon as you hire an accountant, it would be best to establish what accounting system would be used while preparing your business' accounts.

Double Entry Accounting

The double-entry accounting system is a method of bookkeeping where the accounts are balanced. This system focuses on showing the accurate financial picture of the business as all entries are recorded as and when the transactions occur. The accounting equation, Assets = Liabilities + Equity, is the foundation of the double-entry accounting system.

The equation has to be kept in balance while recording every transaction. If you credit one account with a specific amount, another account will have to be debited with the same amount.

For instance, when you pay the rent for your office space, the transaction would debit the rent account. As the rent is being paid in cash, the cash account will be credited. If you pay your rent via cheque, you will credit the bank account in that case.

Example:

If your rent is paid in cash:

Rent a/c                                                                    $1000

To Cash a/c                                                              $1000

If your rent is paid by check:

Rent a/c                                                                    $1000

To Bank a/c                                                              $1000

If you pay your rent in advance, that will be recorded in the books of accounts in the case of the double-entry accounting system. Here, the prepaid rent account will be debited as the asset is decreasing, and the rent account will be credited as there is a decrease in your future expenses.

Prepaid Rent a/c                                                       $1000

To Rent a/c                                                                $1000

Double-Entry Bookkeeping

Double-entry bookkeeping covers the recording aspect of the double-entry system. It mandates a counter entry for every transaction that takes place in your business. It can be a bit conservative for any business to calculate the losses it might incur beforehand.

However, such an approach gives you enough time to take necessary corrective measures. A counter entry can be recorded in the books of accounts if you make some transactions and make up for the losses incurred.

The essence of the double accounting method lies in the working of credit and debit accounts. As a business owner, you need to understand which accounts will be credited and which ones will be debited when a transaction occurs. Debits tend to increase the value of your assets. On the other hand, credits reduce the value of assets that your business possesses.

The Key Differences Between Single Entry and Double Entry Accounting

When you start your creative business, you will have to make some crucial business decisions. One of these decisions is about your business' accounting. You might have heard of both single as well as a double-entry accounting system.

When given a choice, you might find yourself confused about what to choose. You must identify what suits your business better, and you can easily decide which one to go with if you know what makes them different from each other.

Definition

You must know what a single entry or a double-entry accounting system is to decide which one to choose.

The single-entry system is an economical way of bookkeeping. All transactions are just recorded partially in the single entry system making it unscientific at times. The single-entry system gives a partial overview of the business.

On the other hand, the double-entry system records every aspect of a business transaction. The system is based on the fundamental principles of what is accounting, where every dimension of a transaction is recorded in the books of accounts. Several organizations prefer using the double-entry system to gauge their business' financial health.

Business Types

A single-entry system keeps track of all significant business expenses. Most of these business expenses comprise major cash transactions and disbursements. Sole proprietors and small partnership firms generally use the single-entry system of recording transactions.

The double-entry accounting system focuses more on duality, as it is believed that a single transaction affects at least two accounts of any business. This system is used by medium and large-sized organizations where recording everything is mandatory.

Detecting Errors

In the double-entry system, detecting an erroneous entry is quite simple. For every debit, there will be one or more credit entries totaling the same amount. If the debited amount does not match the amount credited, there's an error.

As a small business owner, you might find it extremely challenging to spot an error while following the single-entry system. Single entries are recorded haphazardly, and they fail to take you back to a particular transaction. Rectifying mistakes in a single-entry system is highly challenging as a result.

Preparation of Financial Statements

Every business starts with the objective of growth. A double-entry accounting system lays the groundwork for the preparation of significant financial statements. Adopting this system will remove all kinds of accounting roadblocks that might hamper your business' growth.

If you opt for a single-entry accounting system, preparing any financial statement is out of the question. Single entries cannot be reconciled and converted into financial statements and reports. The ease of converting these entries to concrete statements can become a bottleneck for the company's growth.

Being a small business owner, you don't need to handle all aspects of the business. You can easily outsource its bookkeeping and accounting to someone who can implement it with utmost efficiency. The service you choose to handle your books of accounts will effectively understand how your business will benefit from adopting a double-entry accounting system.

A Double-Entry Accounting Cheat Sheet

As a business owner, you can easily outsource your business' accounting and focus on its other essential aspects. However, you must know some basics to read your books of accounts. Some key concepts that make double-entry accounting easier and much more convenient are given below.

The first rule says that the value of your assets should always be equal to the sum of the liabilities and owner equity.

Assets = Liability + Equity

The equation stated above forms the foundation of the double-entry accounting system.

Another rule that can improve your understanding of the double-entry system is that a debit entry tends to increase the value of assets. In contrast, a credit entry reduces the value of the assets your business holds.

Three golden rules that will help you understand how your books of accounts are working are:

  • You always debit the receivers’ account and credit the givers’ account.
  • Whatever comes into the business, be it cash or an asset, is always debited. On the other hand, if something is going out of the company, it will be credited.
  • All the expenses and losses incurred during your business must always be debited, while revenues and gains should be credited.

These rules will help you understand your company's financial records better.

Do you want to know about double decline balance method which is an accelerated depreciation calculation used in business accounting.

Summary - Should You Use the Double-Entry System?

A double-entry system is an ideal choice for any business. Even if you are new to the game, a double-entry system will give you much more clarity about all of your business' transactions. The system might become complex at times but provides greater clarity for all the stakeholders involved in the business.

You can quickly locate errors and fix them if you opt for a double-entry system of accounting. Also, you can easily make all kinds of financial statements if you have been following this system throughout your business' journey.

Adapting to this system will give you a clear picture of your financial position, which will provide further direction to your business plans. Working with Fincent is the best way to ensure that all your bookkeeping needs are taken care of so that you can focus on growing your business.

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