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What is double-entry accounting?
Double-entry accounting is a method of bookkeeping that tracks where your money comes from and where it’s going. Every financial transaction gets two entries, a “debit” and a “credit” to describe whether money is being transferred to or from an account, respectively. Each accounting entry affects two different accounts: for example, if you sell a cup of coffee, your cash account goes up, and your inventory account goes down.
When making these journal entries in your general ledger, debit entries are recorded on the left, and credit entries on the right. All these entries get summarized in a trial balance, which shows the account balances and the totals of your total credits and total debits. If done correctly, your trial balance should show that the credit balance is the same as the debit balance.
There’s one more common accounting term you should know here: chart of accounts, which is a big list of all your accounts (what kind of transaction in your business is an asset, what’s a liability, what’s an equity, etc.). You can see an example here.
Recording transactions this way provides you with a detailed, comprehensive view of your financials—one that you couldn’t get using simpler systems like single-entry.
How is it different from single-entry?
Single-entry accounting involves writing down all of your business’s transactions (revenues, expenses, payroll, etc.) in a single ledger. If you’re a freelancer or sole proprietor, you might already be using this system right now. It’s quick and easy—and that’s pretty much where the benefits of single-entry end.
Single-entry doesn’t track assets or liabilities, is prone to mistakes, doesn’t tell you much about the state or health of your business, and is the accounting equivalent of carrying around a velcro wallet—fine when you’re a kid, but not very secure, or reputable, when you’re older.
Noting these flaws, a group of accountants—in 12th century Genoa, 13th century Venice, or 11th century Korea, depending on who you ask—came up with a new kind of system called double-entry accounting.
Unlike single-entry, the double-entry system provided accountants with enough information to create all of the major financial statements, including income statements, balance sheets, statements of cash flows, and statements of retained earnings.
“It was just a whole revolution in the way of thinking about business and trade,” writes Jane Gleeson-White of the popularization of double-entry accounting in her book Double Entry.
“You could itemize the profits in each account, so you knew which products you were doing well in and which you weren’t. Then you could start to think about how you would change your business activities.”
In a nutshell, the double-entry method lets you do modern accounting.
Double-entry in action
Let’s say you buy a brand new $3,000 MacBook Pro for your recently-launched blockchain dog food startup.
Under double-entry accounting, you would make two entries: you trade one asset (cash) for another asset (laptop). So you have to adjust both the cash and laptop accounts in your books:
Under double-entry accounting, every debit always has an equal corresponding credit, which keeps the following equation in balance:
Assets = Liabilities + Equity
Accountants call this the accounting equation, and it’s the foundation of double-entry accounting. If at any point this equation is out of balance, that means the bookkeeper has made a mistake somewhere along the way.
In this example, only the assets side of the equation is affected: your assets (cash) decrease by $3,000 and your laptop assets increase by $3,000, and the equation remains balanced.
Let’s try another example. Let’s say you just bought $10,000 of pet food inventory on credit.
In this case, the asset that has increased in value is your Inventory. Because you bought the inventory on credit, your accounts payable account also increases by $10,000.
Let’s take a look at the accounting equation again:
Assets = Liabilities + Equity
In this case, assets (+$10,000 in inventory) and liabilities (+$10,000) are both affected. Both sides of the equation increase by $10,000, and the equation remains balanced.
Last example: how do you record accounts receivable under this accounting method?
When you send an invoice to a client after finishing a project, you would “debit” accounts receivable and “credit” the sales account.
After the client pays you, you would then debit your cash account, and credit accounts receivable.
A double-entry accounting cheat sheet
It can take some time to wrap your head around debits, credits, and how each kind of business transaction affects each account and financial statement. To make things a bit easier, here’s a cheat sheet for how debits and credits work under the double-entry bookkeeping system.
Debits:
- Increase an asset account, or decrease a liability account or equity account (such as owner’s equity).
- Increase an expense account.
- Decrease revenue
- Are always recorded on the left side
Credits:
- Increase a liability or equity account, or decrease an asset account.
- Decrease an expense account.
- Increase revenue
- Are always recorded on the right side
Should I use double-entry?
If your business is a very simple sole proprietorship—one that doesn’t have any inventory, doesn’t have any debts, has only one employee, and not many accounts to keep track of—single-entry might suffice for your accounting needs.
If your business is any more complex than that, most accountants will strongly recommend switching to double-entry accounting.
Why? Double-entry provides a more complete, three-dimensional view of your finances than the single-entry method ever could.
Because you’re tracking where your money is coming from and where it’s going, you can later collate that information into financial statements, which give you insights into the profitability and health of the various parts of your business. That’s a win because financial statements can help you make better decisions about what to spend money on in the future.
Double-entry accounting also decreases the risk of bookkeeping errors, increases the transparency of your finances, and generally adds a layer of accountability to your business that single-entry can’t provide.
If you want your business to be taken seriously—by investors, banks, potential buyers—you should be using double-entry.
Double-entry in accounting software
Most popular accounting software today uses the double-entry system, often hidden behind a simplified interface, which means you generally don’t have to worry about double-entry unless you want to.
If you’d rather not have to deal with accounting software at all, there are bookkeeping services like Bench (that’s us), that use the double-entry system by default.
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