A Relatively Painless Guide to Double-Entry Accounting
If you run a small business, you’ve probably come across the term “double-entry accounting,” thought, “double the accounting, double the boredom”, and put it out of your mind.
But when it comes to setting up your own books, you have to make a decision: double-entry or single-entry? Suddenly it’s a practical issue.
In this article, we’ll explain double-entry accounting as simply as we can, how it differs from single-entry, and why any of this matters for your business.
What is double-entry?
Double-entry accounting is a system of accounting that tracks where your money comes from and where it’s going.
Under double-entry, an equal amount of money is always transferred from one source—or “account”—to another account. The terms “debit” and “credit” describe whether money is being transferred to or from an account, respectively.
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 cash assets 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.
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 double-entry accounting.
- Increase an asset account, or decrease a liability or equity account.
- Increase an expense account.
- Decrease revenue
- Are always recorded on the left.
- Increase a liability or equity account, or decrease an asset account.
- Decrease an expense account.
- Increase revenue
- Are always recorded on the right.
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.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.