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What is Double Entry System of Accounting?
The double-entry system is a method of accounting that records financial transactions in two accounts, balancing the accounting equation:
Assets = Liabilities + Equity
Transactions are recorded in debits and credits, with each having an equal and opposite effect. It is mathematically accurate and the most widely used system of accounting.
Single Entry System of Accounting
While the double entry system records every transaction twice, there exists a single entry system which records every transaction only once — this is the single entry system of accounting.
The single entry system is a simplified method of bookkeeping that records only one side of a transaction, typically the cash or bank account, without considering the corresponding entry for the other account.
It does not provide a complete picture of the financial transactions and is only used by small businesses or individuals who have limited accounting needs. It does not give the whole picture of the business’s financial performance and is not considered to be mathematically accurate.
For this reason, almost all businesses and accountants prefer the double-entry system of accounting.
Differences Between Double Entry & Single Entry System
Here are some examples of single-entry and double-entry accounting:
- A small business owner records all cash sales in a cash register.
- A freelancer records all income and expenses in a spreadsheet.
- A company records a sale of goods by debiting the accounts receivable account and crediting the sales revenue account.
- A company records the purchase of inventory by debiting the inventory account and crediting the accounts payable account.
|Feature||Single-entry accounting||Double-entry accounting|
|Recording method||Each transaction is recorded only once.||Each transaction is recorded twice, once as a debit and once as a credit.|
|Completeness||Does not provide a complete picture of a business’s financial health.||Provides a more complete and accurate picture of a business’s financial health.|
|Accuracy||More prone to errors, as there is no built-in mechanism for checking accuracy.||Less prone to errors, as debits and credits must always be equal.|
|Complexity||Simple and straightforward system.||More complex system, but provides more information.|
|Suitability||Suitable for small businesses with a low volume of transactions.||Suitable for all businesses, regardless of size or volume of transactions.|
Types of Business Accounts
A transaction is any activity that results in the exchange of goods and services for cash or credit. Under the double-entry system, all transactions are recorded twice under the following seven accounts.
- Assets: Any value that the company owns (machinery, goodwill)
- Liabilities: Any value that the company owes (loans, accounts payable)
- Equities: Value of the shares issued
- Revenue: Value earned by the company by selling goods or services
- Expenses: Value spent by the company in operations
- Gains: Non-revenue incomes like interest income
- Losses: Non-revenue expenditures like loan payments
Debits and Credits
- Every transaction has two sides: one debit entry and one credit entry.
- Debit and credit is the most efficient way to record the flow of value in and out of a business.
- 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.
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 the business purchased sugar of Rs 1000 with cash on the 11th of November.
How are Entries Recorded?
In the single entry system, entries are recorded in a cash book or cash register, primarily focused on cash or bank transactions.
Cash inflows like revenue are recorded as receipts, while cash outflows like expenses are recorded as payments. Non-cash transactions like depreciation on assets are generally not recorded, making this an incomplete record of accounts.
Under the double entry system, entries are recorded in the following system:
- Journal: The first record of a transaction is made in the Journal, where information is recorded about the amounts debited or credited, and a brief description of the transaction.
- Ledger: From the Journal, information is then transferred to ledger accounts, where all transactions are grouped into their respective accounts and the final account balance is calculated.
- Trial Balance: The account balances calculated in the ledger are then taken into the trial balance, where the final debit and credit balances are calculated. The two balances should always be equal – this is how the trial balance ensures mathematical accuracy.
- Financial Statements: From the trial balance, information is then transferred to the three main financial statements – Income Statement, Balance Sheet and Cash Flow Statement.
Benefits of Double Entry System
The double entry system is the most widely used method of recording financial transactions, accepted universally and across all domains – for good reason.
- Scientific and Accurate: Since 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.
- 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.
- 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.
Example of Double Entry System
Let’s say a small retail store sells a product for Rs 100 in cash. This transaction will involve two accounts: Cash Account and Sales Revenue Account.
1. Cash Account:
– Debit: Rs 100
– This indicates an increase in the Cash account, as the store receives $100 in cash from the sale.
2. Sales Revenue Account:
– Credit: Rs 100
– This indicates an increase in the Sales Revenue account, as the store earns Rs 100 in revenue from the sale.
The double entry system ensures that every transaction has at least two entries, one debit, and one credit, which keeps the accounting equation (Assets = Liabilities + Equity) balanced.
In this example, the total debits (Rs 100) equal the total credits (Rs 100), ensuring that the books are in balance. This method helps maintain accurate financial records and enables businesses to track their financial health effectively.
Disadvantages of Double Entry System
Despite the obvious advantages, the double entry system also has its drawbacks. Since it is complex, recording transactions using the double entry system requires knowledge of accounting. It is also time consuming and costly since manual entry could result in errors.
For this reason, many businesses choose to make use of accounting softwares like Zoho or Tally, which can be expensive.
Automated Accounting & Banking
Understanding the double entry system is the first step towards a full understanding of business finances – whether you are an individual, investor or business owner.
But maintaining books of accounts and recording transactions manually becomes tedious and is highly error-prone.
That’s why there’s solutions like RazorpayX to automate all your banking functions, including accounting integrations with the best accounting software on the market, and more:
- Unlimited multi-user access for your finance team & CA
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