Double-entry bookkeeping isn’t as cumbersome as it sounds. In reality, it’s an accounting system that records every transaction into two accounts: a debit to one and a credit to another.
Keep reading for the ins-and-outs of double-entry bookkeeping, including why it’s important, how to do it, and the nitty-gritty when it comes to the rules of this accounting system.
What is double-entry bookkeeping?
Double-entry bookkeeping is an accounting system where your business’s transactions are included in at least two accounts using debits and credits.
Let’s break this down.
You own a catering business that’s world-famous for your flaky croissants and speedy delivery. But to get your orders out on time, you’ve got to purchase some new wheels: $20,000 for your delivery truck. With double-entry bookkeeping, you would record this in two accounts.
First, you credit your “catering expense account” for $20,000 and then debit your “cash account” for the same amount. You do both because your “catering expense” assets are now worth $20,000 more, and you have $20,000 less cash.
(And many more orders for those mouth-watering croissants.)
When is double-entry bookkeeping used?
Are you a small business owner who employs more than one worker, or is looking to apply for a loan? Then double-entry accounting might be right for you—especially because it gives you a more accurate view of how fast your business is growing.
Now, if you’re a public company, you have to use the double-entry bookkeeping system and follow the rules and methods that have been outlined by GAAP or IFRS.
Pardon our acronyms. Let us explain.
Remember when we mentioned the word “rules”? Well, here’s one: in the United States, there’s something called the Financial Accounting Standards Board (the FASB). It’s a non-governmental body that decides on generally accepted principles (GAAP) in accounting, like the official rules and steps for double-entry bookkeeping.
Then you’ve got the International Accounting Standards Board (IASB). This is another non-governmental body. It creates the International Financial Reporting Standards (IFRS) for any official accounting rules outside of the US.
Okay, back to business.
Here’s the bottom line: If you’re a public company, double-entry bookkeeping is a must, and if you’re a small business owner with at least one employee or you’re looking to get a loan, then you should consider this system.
More on that below.👇
Why is double-entry bookkeeping important?
Double-entry bookkeeping is important for small businesses for a number of reasons, one of which is financial health.
With double-entry bookkeeping, you get a clear view of how your business is doing financially—short and longer term. Take the catering scenario as an example. Without double-entry bookkeeping, you might miss an opportunity to highlight your growth or have a clearer understanding of where your money went, and what it counts for.
No, not the croissants… but the dough that makes them and the van that delivers the goods.
By tracking all entries in two accounts, double-entry bookkeeping also lets you spot and resolve any mistakes quickly and with accuracy. You’ll also be able to identify the profitable aspects of your business, and the ones that are less so.
And when it comes to things like loans and investments, double-entry bookkeeping gives you a snapshot of your financial standing, so banks and investors can get a clear understanding of where you’re at and where you can grow.
What are the rules of double-entry bookkeeping?
Double-entry bookkeeping has three major rules that need to be followed. And yes, please feel free to bookmark this page for safekeeping. 🔐
- Each and every business transaction or accounting entry must be recorded in a minimum of two accounts in the books. (Hence the “double” part of the name.)
- For every transaction, total debits recorded must always equal the total credits recorded.
- Your total assets have to equal the total liabilities plus equity—the net worth or capital—of your business. In other words, they have to balance out.
Double-entry bookkeeping: An example
Before we jump in, let’s review some key terms: asset accounts and liability accounts.
An asset account records the monetary value of what you own, like the money in your checking account, inventory, tools, buildings, vehicles, and more.
A liability account records how much your business owes on things like loans, lines of credit, or mortgages.
Now that we have that covered, let’s see what recording your transactions the double-entry bookkeeping way can look like.
Imagine this: you own a dog “spaw” (see what we did there?) and purchase $500 of flea-be-gone shampoo on credit. When you make the payment for the inventory you’ve purchased, your account payable decreases by that same amount, as does your cash account. In your general ledger—your main accounting record—you’ll debit the account payable (which is a liability account) and credit your cash account (an asset account).
Double-entry bookkeeping vs single-entry bookkeeping: What's the difference?
You might be wondering if there’s another way to record your transactions. There might just be! It depends on the type of business you run, how many employees you have, and how many transactions you need to track.
Let’s start with single-entry bookkeeping.
Picture a running total of your checking account, and you’ve almost got it. Essentially, it tracks deposits and purchases, and then the difference between those two is your cash on hand. Single-entry bookkeeping works for very small businesses with very small amounts of transactions.
But if you have more than a handful of those, and more than one employee, double-entry bookkeeping is the way to go.
Double-entry bookkeeping will let you see all of the money coming in and all of the money that's going out. Better yet, it tracks the sources of each transaction. For example, if you notice the debit column that your doggie spa brought in $3,000 in sales, but you only have $1,000 in cash, double-entry bookkeeping acts as your crystal ball, showing you that there's another $2,000 from another source, like credit card payments.
Being able to see both sides of your financial transactions allows you to do a side-by-side comparison of credits against debits, helping to spot any discrepancies.
What's the difference between debits and credits in double-entry bookkeeping?
Okay, folks: buckle in for a ride. This part of the journey can cause a bit of confusion sometimes, but we’ll steer you in the right direction.
In double-entry bookkeeping, debits and credits are used to track transactions and keep the balance sheet equation equal. Simple enough, but there are some basic rules you’ve got to keep in mind:
So, where’s the confusion? Usually it comes from the fact that debits must equal credits. Remember, in every account—whether that’s asset or liability—there must be both debit and credit entries. And both must be balanced: always.
- First, debits are always on the left side. Credits are on the right.
- Next, there’s accounts. Most of your asset and expense accounts will increase with each debit entry, and most of your liability and revenue will also increase with each credit entry.
- Lastly, debits and credits must always be equal.
Double-entry bookkeeping and the software that helps
Growing your business from a one-worker-shop to a multi-employee empire? Then double-entry bookkeeping might be your next best friend.
As we covered above, this type of accounting system tracks your transactions in at least two accounts using debits and credits, and those debits and credits must always be equal. It’s ideal for seeing the financial health of your business, plus tracking and resolving discrepancies in the blink of an eye, or in the case of a sale, the swipe of a card.
And when you’re too busy with sales to manage the accounting alone, lean on us. Wave makes accounting easy so you can get back to growing your business. Which may also entail baking croissants.
On that note, we’ll take a pain au chocolat, please. 🥐
The information and tips shared on this blog are meant to be used as learning and personal development tools as you launch, run and grow your business. While a good place to start, these articles should not take the place of personalized advice from professionals. As our lawyers would say: “All content on Wave’s blog is intended for informational purposes only. It should not be considered legal or financial advice.” Additionally, Wave is the legal copyright holder of all materials on the blog, and others cannot re-use or publish it without our written consent.