There are two ways of recording financial transactions.
The simple way: Using a single entry system – which is so easy that it cannot be used as your business grows.
The complex but vastly superior way: Using the double entry system.
What makes the double entry system of accounting better for businesses & individuals alike?
This blog discusses in detail what exactly double-entry accounting is, and the advantages it offers over single entry accounting.
What is the Double Entry System of Accounting?
To understand what the double entry system of accounting is, we must first understand that there are two sides to every transaction.
Let’s understand using the example of a fictional bakery.
Introducing: Razor Bakery. Our name is sharp, but our bread is soft! 🍞
Remember in this blog, the owner of Razor Bakery, Mrs. Pay, used the single-entry system to record her transactions.
Since then, she’s realized that the single entry system isn’t the best fit for her business, and so in this blog, she will be using the double entry system of accounting.
Let’s see how she does this.
Mrs. Pay purchases sugar worth Rs 1000.
In this situation, Rs 1000 worth of sugar has been added to the business, and cash worth Rs 1000 has been deducted.
The two sides of this transaction are as follows:
This is the fundamental concept of the double entry system. Every transaction recorded with the double entry system has a debit and its corresponding credit.
Let’s now understand what “debit” and “credit” is.
Debit & Credit in Double Entry System of Accounting
Debit and credit is the most efficient way to record the flow of value in and out of a business. Every transaction has two sides: one debit entry and one credit entry.
This ensures mathematical accuracy and an easy understanding of a business’s finances.
In a transaction, the debit and credit aspects are both equal and opposite. Anything that comes in must be debited, and anything that goes out must be credited.
Let’s take the example of Mrs. Pay’s sugar purchase.
From Razor Bakery’s perspective, sugar has come in and cash has gone out.
Therefore, in accounting terms, sugar has been debited and cash has been credited.
This system of visualizing transactions in debits and credits shows us the flow of money – where the money is from and where it’s going.
Simply by looking at this table, we can tell that Mrs. Pay bought sugar of Rs 1000 with cash on the 11th of November.
TL;DR: debit what comes in, and credit what goes out.
Advantages of Double Entry System
The double entry system is the most widely used method of recording financial transactions, accepted universally and across all domains. Let’s take a look at all the advantages of this system of accounting.
1. Scientific and Accurate
Since the double entry system accurately records both sides of the transaction, we can be assured that double entry system books of accounts are both scientific and accurate.
2. Consistent and Universal
The double entry system of accounting follows very specific rules and formats. This ensures uniformity in the books of accounts across businesses. Anybody familiar with this format would be able to read any company’s books of accounts, as long as they follow the double entry system of accounting.
3. Scope for Financial Analysis
The double entry system of accounting maintains comprehensive, chronological records of every single transaction that a business enters into. This gives plenty of scope to make detailed charts on the growth of the business. There are accounting ratios that analysts use, which can only be derived from double entry books of accounts.
Disadvantages of Double Entry System
While the double entry system is definitely the winning accounting method, it does have its drawbacks.
Maintaining books of accounts that subscribe to the double entry system can be a bit expensive since businesses would need to hire an accountant and purchase accounting software.
However, considering the benefits of maintaining double entry books of accounts, this amount is more of an investment in your business’s growth!
2. Requires Expertise
Unlike the simple single entry system which can be done by anybody, the double entry system needs skill and expertise. Since most businesses end up hiring an accountant for tax purposes anyway, the expertise required to maintain double entry books of accounts is fulfilled in the end!
This blog is part of our Bookkeeping for Founders series, where we explain the basics of accounting to help founders get a better understanding of their finances.
Being able to read, analyze and interpret how and where money is going gives founders power over their decisions!
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1. What is the double entry system of accounting?
The double entry system of accounting is a method of recording financial transactions in a mathematically accurate, universally accepted way.
2. What is debit and credit in double entry system?
Debits and credits show the flow of value through a business. Any value that is added to the business is shown as a debit, and any value that is deducted is shown as a credit.
3. What is an example of double entry system?
Lets say you buy a pen with cash. You deduct cash and add a pen – meaning cash has been credited and pen has been debited.
4. Where is the double entry system used?
Double entry system of accounting is used to record a business’s financial transactions. It is the best way to record and measure how a business earns and expends money as well as its growth over time.
5. Why is the double entry system of accounting better than single entry sytem?
The double entry system is scientific and mathematically accurate as it records both sides of a transaction. The double entry system also follows a standard set of rules and formats, making it universally comprehensible.