Double-entry Accounting Explained In Simple Terms
Double-entry accounting is really very simple provided you follow these rules.
- Everything starts with a Source Document. That is usually an invoice for something you have sold or a receipt for something you have bought.
- Each Source Document is copied into your double-entry system by creating Transactions.
- A Source Document always contains at least one complete transaction, and depending on your accounting system sometimes more.
- A double-entry transaction consists of a minimum of two Entries.
- That is, each transaction you create must have at least two entries.
- Each entry contains either a Debit or a Credit.
- Debits and Credits are amounts of money.
For a Transaction to be true to the double-entry principle, two further rules must be obeyed:
- The entries involved must contain at least one Debit and at least one Credit.
- The value of all the Debits must equal the value of all the Credits for a transaction to be considered complete.
Furthermore, each entry must consist of a minimum of four pieces of information as follows:
1. Date (the date on which the transaction occurred)
2. Reference (so it can be identified with a source document)
3. Amount (known as a Debit or a Credit in any currency)
4. Account (whose balance will be increased or decreased by the amount depending on whether it is a Debit or a Credit)
Every transaction tracks an amount of money from one account to one or more other accounts.
As long as the Debit amounts equal the Credit amounts, then we know that all the money has been accounted for.
The idea that we are doubling the amount of data by making two entries is a myth.
The two (or more) entries merely record the flow of money from one account to another. That is its sole purpose.
It is called Double-entry because two entries are the minimum required to record the two accounts involved in every transaction.
For example, buying a computer for your business involves your Bank and your Equipment accounts.
Once the transaction has been entered, a look at your books will show how much you have left in your bank and how much you have spent on equipment.
If you don’t know these things, it is unlikely your business will stay profitable as you will have no idea what is going on.
This is why double-entry accounting is used universally around the world and has been in existence for many thousands of years.
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