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What is Double Entry Accounting?
If you're like most small business owners or new start-ups, you probably know a lot about the product or service that you provide in your business, but very little about accounting and some of its fundamental principles, such as double-entry accounting. You may have heard about it, but are unaware of what it actually means and when it is being implemented during the accounting process. Below is an explanation of double-entry accounting, its basic formula and an overview of its functions.
Double-Entry Accounting Defined
Double-entry accounting consists of a transaction that is recorded into two or more general ledger accounts, where by the debits and the credits are of equal amounts. It suggests that the entry was posted with a higher level of accuracy than it would be if the total debits and credits were different amounts. Consider the two transactions below for example; the first consists of two entries, where the debits and the credits are of equal value, and the second entry consists of four transactions, where the debits and the credits are of equal value.
Although the double-entry accounting system allows bookkeepers and accountants to minimize errors, it doesn't prevent them from posting entries to the wrong account. For instance, in the example above, rent expense could have been erroneously posted instead of rental car expense. So, double entry accounting doesn't prevent errors from occurring, but it does allow bookkeepers and accountants to confirm whether or not the double-entry rule has been recorded properly by ensuring that all debits equals all credits in any given transaction.
The Double Entry Accounting Formula
The double entry principle is centered on the accounting equation, assets = liabilities + owner’s equity.
Double entry accounting is one of the basic fundamental principles taught in accounting 101. It is a part of a set of rules and accounting standards that dictate how accountants must practice accounting, which is known as Generally Accepted Accounting Principles, or GAAP, which has been set forth and governed by The Financial Accounting Standards Board, or FASB, www.fasb.org, the Security Exchange Commission, or the SEC, www.sec.gov and other respected industries that have performed accounting practices and procedures over the years.
General Functions of Double-Entry Accounting
There are also rules for recording transactions under the double-entry accounting rule that involves increases or decreases to various accounts. The primary accounts affected are assets, liabilities and owner’s equity, however other account categories exist as well, such as expenses, revenues and cost of goods sold accounts. What's important is being aware of which accounts have debit balances and which have credit balances. What that means is accounts with debit balances are increased when debit entries are posted and accounts with credit balances are increased when credit entries are posted as indicated in the sample below.
You'll notice in the example above that each of the accounts appear above what looks like a “T”, which are referred to as T accounts. T accounts are common visuals used by bookkeepers and accountants to journalize or determine which accounts to post an entry to, along with where to post the corresponding debits and credits. You will also notice that all of the debits are on the left side of the T accounts and all of the credits are on the right side. T accounts make it easier to record (or post) entries and follow the double-entry accounting rules.
For more information on double-entry accounting or to learn more accounting tips for small business owners, please visit the Small Business Administration at http://www.sba.gov/sites/default/files/Introduction%20to%20Accounting_Transcript_0.pdf