Double-entry accounting sounds like double the work, but it’s a vital system to have in place. The inaccuracies that can happen in a single-entry system are all but eliminated in a double-entry accounting system.
The terminology of double-entry accounting might be difficult to keep straight, especially if you are accustomed to the terms “debit” and “credit” as they’re used by banks. You might find it helpful to create a little cheat sheet to help you keep debits and credits straight.
Double-entry accounting cheat sheet
Here’s what you need to remember:
Your accounting software most likely manages double-entry accounting for you. You might not be aware because it happens behind the scenes, but if you can produce a balance sheet, your double-entry accounting system is already in place.
If you are ever confused about how to record a transaction in your double-entry accounting system, reach out to your bookkeeper or accountant. They will be happy to help you determine how to record the transaction and explain the impact the transaction has on your financial statements.
Franciscan monk Luca Pacioli is credited for “creating” double-entry accounting, since his book “Summa de Arithmetica, Geometria, Proportioni et Proportionalita,” published in 1494, is one of the earliest records of the system.
But Pacioli didn’t actually invent the concept. Double-entry accounting had been in use for decades prior to Pacioli’s publication. Earlier in the 15th century, merchants realized they needed a more accurate way to keep financial records. Prior, many merchants kept a running list of income and expenses (a sort of single-entry accounting system). This was prone to errors, and it couldn’t fully capture the nature of complex transactions.
Regardless of who actually “invented” double-entry accounting, it has become the standard method of accounting used by accountants and bookkeepers — which makes it important for you, as a business owner, to understand it.
Why it’s important
In physics, we have Newton’s third law, which says for every action there is an equal and opposite reaction. Even if you don’t remember physics, you probably remember this law, because it is used to explain pretty much all cause and effect situations — physical or otherwise.
Think of double-entry accounting as Newton’s third law for money. Every part of a financial transaction has an equal and opposite counterpart. Just like Newton’s third law keeps things in balance in the physical world, double-entry accounting keeps things in balance in the accounting world.
You can see this in action on your business’s balance sheet. If you study your balance sheet, you will see your total assets are equal to the sum of your total liabilities and equity. (If your balance sheet doesn’t show this, it is out of balance and you need to speak with your accountant or bookkeeper right away to remedy the error.) Your balance sheet is the expanded version of the accounting equation:
Assets = Liabilities + Equity
Even though your income and expenses show up on another financial statement (the income statement, or profit and loss statement), they also impact the balance sheet. All transactions impact the balance sheet in some way, which is why the accounting equation relates to that particular financial statement.
Each transaction in a double-entry accounting system has two sides. The first side of the transaction is called the debit side of the transaction. The offsetting side of the transaction is called the credit side of the transaction.
You are probably familiar with the terms debit and credit from banking. When you deposit money, the bank credits your account. When you spend money, the bank debits your account.
Debits and credits in banking are the exact opposite of how they work in accounting for your business. There is actually a very logical reason for this: When the bank talks about debits and credits, they are talking about how your transaction impacts their books. That same transaction has the exact opposite impact on your books.
Debits are recorded on the left side in double-entry accounting. If you look at a journal entry for an expense, you’ll see something that looks like this:
Insurance Expense $500 Checking Account $500
The debit side of the transaction is always listed first, and it is recorded to the left (the credit side is indented, or recorded on the right side).
Debits always increase assets, expenses and dividends.
Just like they always increase certain accounts, debits also decrease certain accounts. Income, liabilities and equity are all decreased by debits.
Credits, on the other hand, are recorded on the right side with double-entry accounting. Looking at our example above, the checking account balance is credited $500. If we were to look at the transaction using a t-account (or general ledger), it would look like this:
Credits increase the exact same accounts debits decrease. Income, liabilities and equity are all increased by credits.
Credits decrease assets, expenses and dividends.
Because debits and credits increase and decrease the exact opposite types of accounts, the books in a double-entry accounting system remain in balance at all times.
What's single-entry accounting?
In a single-entry system, the transaction is only recorded once. This is most likely how you managed your business’s books when you first started. Chances are, you kept a record — likely a spreadsheet — where you recorded your sales or other income. You kept a second record where you recorded your cash outflows, like expenses, loan payments and your draws from the business.
In this sort of single-entry system, there is no offsetting side to the transaction. Although this keeps the recordkeeping very easy, it also means there is no accounting equation or balance sheet to ensure your books stay accurate and in balance.
In a double-entry accounting system, it is almost impossible to either omit or double record transactions that are run through the business’s bank or credit card accounts. In a single-entry system, there is no way to make sure all transactions are captured (or that some aren’t duplicated). You are missing half of the equation in a single-entry system.
Double-entry accounting software
If you use accounting software like QuickBooks, Xero or Freshbooks, you might be feeling a little concerned right about now. When you enter transactions into your software, you aren’t making debits and credits — you’re just entering your numbers into the software, right?
Most modern accounting software is based on the double-entry accounting system. When you enter your transactions into the software — typically using a form that looks like a check, invoice or bill — the second part of the transaction is automatically happening behind the scenes as part of the software’s programming.
Let’s look at an example. When you write a check in QuickBooks, you only enter the following information:
The vendor’s name.
The date of the check and check number.
The amount of the payment.
The category (account in the chart of accounts) for the transaction.
But, at the top of the screen in a drop-down box, you also have the option to choose the checking account for this transaction. On the surface, you are only entering one-half of the transaction (the debit), but behind the scenes, QuickBooks is employing double-entry accounting and recording the credit. You can see this by running a transaction journal report.
If you’re not sure whether your accounting system is double-entry, a good rule of thumb is to look for a balance sheet. If you can produce a balance sheet from your accounting software without having to input anything other than the date for the report, you are using a double-entry accounting system.
Keeping double-entry accounting on track
Today’s accounting software makes it easy to do your bookkeeping in just a few minutes a day. This ease of use can make it easy to overlook a critical task in your monthly bookkeeping procedures.
Your accounting software will keep your balance sheet in balance (if it doesn’t, there is usually an underlying bug in the software causing the problem. Your bookkeeper can help you troubleshoot this). But in order to keep your double-entry accounting system in tip-top shape, you must complete the reconciliation process for your checking, savings, credit card and loan accounts on a regular basis.
Sometimes, automated bank feeds either miss some transactions or duplicate them. Other times — as with loan payments, which include both principal and interest — you don’t always know how the multiple parts of the transaction should be recorded at the time of the transaction.
The reconciliation process makes sure all the transactions that are hitting your asset and liability accounts are properly recorded in your bookkeeping. This, in turn, ensures your financial statements accurately reflect the financial position of your business.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.