The concept of double entry bookkeeping has traditionally been within the prevue of qualified accountants and certain other experienced persons who have managed some or all of a business’s financial recording.
With an increased number of business owners seeking to control costs and to take on more of their own accounting functions and some of these choosing simple manual system, understanding double entry bookkeeping remains an important element to accomplishing this.
What is Double Entry?
Double entry is the concept in accounts where every transaction results in there being two entries made in the bookkeeping records. This rule exists without exception.
For example, if a business buys a packet of envelopes, even though there is a single purchase, the transaction results in two accounts in the bookkeeping system being affected. In the above example the cash account balance would be reduced to show the outflow resulting by making the purchase and the stationery account would be increased to show that money has been spent in this category.
How Difficult is Double Entry?
Depending on the commentator, some would say that double entry bookkeeping is a difficult concept to grasp and requires a significant amount of formal training and practical learning in order to graph this difficult concept.
Others would say that the principles are commonsense and that with the help of a few examples, most accounting transactions can be correctly analysed and placed in the right part of the bookkeeping system.
Debits and Credits
Accepting that every single transaction results in a duel posting in the accounts is something that most people can accept without much resistance.
Perhaps arguably the most difficult concept involved in understanding double entry bookkeeping is use of debits and credits.
Again for every transaction, there must be one debit amount and a compensating credit of the same value. That is why the books always balance, or at least should do.
There are two potentially mind resistant elements involved in getting to grips with how debits and credits are used in accounting.
The first is that these are used in the opposite way our bank accounts work. When someone tells you that your bank account has been credited with £500, you think of it as your bank balance has increased and that you are £500 richer.
In bookkeeping a £500 credit on the business’ bank account means a reduction, an outflow of that amount meaning in simplistic terms that the business is £500 poorer.
The reason for this apparent discrepancy is not that banks or businesses for that matter are attempting to be awkward or confusing, it is merely that each entity looks at debit and credits from their own point of view.
By way of explanation, when a bank credits your account with £500, it is effectively crediting it own account. The credit, as far as it is concerned is a reduction in its balance in the same way that an outflow to buy envelopes is a credit on a business bank account.
The second anomaly is the way debits and credits are used in bookkeeping is the apparent lack of consistency in the way they are applied.
When looking at the profit and loss account, a credit is a positive event often meaning an additional sale or interest received.
On the balance sheet however the opposite applies where a debit signified an increase in the business’ assets (and therefore value) and a credit such as the bank account entry when buying envelopes is a negative aspect.
There is no doubt that understanding double entry booking would be a lot easier if a debit could be universally classed as wither good or bad (for the business) and the same for credits.
Profit and Loss Account versus Balance Sheet
So far we have established the every single bookkeeping entry must consist of both a debit and a credit and thus the next stage in understanding the double entry methodology is to establish a set of rules which can be applied so as to make correct inputs.
Simple rules of thumb to follow when looking at a single transaction is to establish the easier of the two required entries and then, by process of elimination determine the remaining one.
In the profit and loss account, a credit is generally benefits the business and a debit is an expense and therefore has a negative impact for the operation.
Conversely, in the balance sheet, credits are negative as far as the business is concerned whilst debits are judged as positive.
To take another example, the cash purchase of a car by the business has the following two entries:
The first is an entry in a fixed asset account, probably motor vehicles category.
The second is to the cash account which was used to buy the car.
So in deciding which of these two accounts to debit and which to credit consider which categories are affected and whether they lie on the balance sheet and or the profit and loss account.
Looking at the chart of accounts we can see that both the motor vehicles and cash accounts are on the balance sheet.
Gaining a car and increasing the assets of the business is viewed as positive and therefore we would debit the motor vehicles account with the purchase price. Conversely, the purchase has resulted in a diminishing cash balance and therefore represents a negative and a credit to the cash account.
Conclusions
These simple principles can help bookkeeping novices gain and understanding of double entry and how to make basic accounting entries.
It is of course wise to initially have the worked performed checked by an appropriate experienced person to ensure that the entries are correct and that the principles are being applied soundly.
