Double-entry bookkeeping: Guide for Small Business Owners

As a small business owner, knowing which accounting practices you should use can be confusing. However, you must remember the fundamental accounting principles for your business’s finances, one of these crucial fundamental principles is double entry bookkeeping.

Principles of double entry bookkeeping is an important concept that drives every accounting transaction in a company’s financial reporting. Business owners must understand this concept to manage their accounting process and analyse its financial results. Use this guide to learn about the double entry bookkeeping system and how to post accounting transactions correctly within the general ledger.

While bookkeeping refers to the day-to-day journal entries of a business, and accounting uses the information in those journals to create reports, when used in relation to the double-entry system, it’s often called either double entry bookkeeping, or double entry accounting.

What is double entry bookkeeping?

Double entry accounting is the standardised method of recording every financial transaction in two different accounts within the general ledger. For each credit entry within the general ledger there must also be a corresponding (and equal) debit entry.

The term 'bookkeeping' refers to a business’s record-keeping process. A bookkeeper reviews source documents for instance receipts, invoices, and bank statements, and uses those documents to post accounting transactions within a proper accounting software solution. If a business ships a product to a customer, for example, the bookkeeper will use the customer invoice to record revenue (credit entry) for the sale and to post an accounts receivable entry (debit entry) for the amount owed.

When entering business transactions into the accounting software, accountants need to ensure they link and source both the debit and credit entry. Linking each accounting entry to a source document is essential because the process helps the business owner justify each transaction.

Bookkeeping supports every other accounting process, including the production of financial statements and the generation of management reports for company decision-making.

Why is double entry bookkeeping important?

Double entry bookkeeping is the standard method of accounting, and using it provides a few of important benefits:

• Provides a clear view of your company’s financial health via the balance sheet
• Allows you to spot and resolve errors quickly within the general ledger
• Helps identify profitable and unprofitable aspects of business
• Snapshot of your business that banks and investors can easily understand

How does single entry bookkeeping differ from double entry?

Single entry bookkeeping is much like the running total of a current account. You see a list of deposits, a list of purchases, and the difference between the two equals the cash on hand. For very small businesses with only a handful of transactions, single entry bookkeeping can be sufficient for their accounting needs.

Double entry bookkeeping shows all of the money coming in, money going out of the general ledger, and, most importantly, the sources of each business transaction. If you see in the credit column that you took in $1,000 in sales, but you only have a $500 debit entry in an asset account called “cash”, double entry bookkeeping will show that you will also have a debit entry of $500 in another asset account from some other source, like credit card transactions. 

Double entry bookkeeping creates a 'mirror image' of both sides of each financial transaction within the general ledger, allowing you to compare one column of credits against a column of debits and easily spot any discrepancies. Single entry bookkeeping doesn’t allow for this type of verification. Although single entry bookkeeping is simpler, it’s not as reliable as double entry bookkeeping and isn’t a suitable accounting method for medium to large businesses.

What are the principles of double entry bookkeeping?

• For every business transaction entered in the general ledger, there must be an equal debit and credit entry in different general ledger accounts. 
• The debits will be listed in a column on the left-hand side of the general ledger sheet, and the credits listed in a column on the right-hand side of the page.

When totalledup, these columns of debits and credits will be equal to one another.

How to record a journal entry

Accountants will use the general journal as part of their record-keeping system. The general journal is an initial record where accountants log basic information about a business transaction, such as when and where it occurred, along with the total amount. Each of these recorded business transactions are referred to as a journal entry.

A journal entry records debits and credits to post an accounting entry, along with a description of the transaction. You post journal entries into columns, and the left-hand column lists the account number and account title. To the right, you have two columns, one for debits and one for credits. A detailed explanation of the transaction is posted below each journal entry.

The double entry bookkeeping system uses debits and credits to post accounting transactions and keep the balance sheet equation equal.

This method is often misunderstood, so it’s essential to understand these ground rules:

• A debit entry is on the left side of the accounting entry, and credit entries are on the right side.
• Most asset accounts and expense accounts are increased with a debit entry, while most liability and revenue accounts are increased with credit entries.
• The total dollar amount of debits must always equal the total dollar amount of credits. If you attempt to post an entry into accounting software that is not balanced, you’ll get an error message.

What causes confusion is the difference between the balance sheet equation and the fact that debits must equal credits. Keep in mind that every account, whether it’s an asset, liability, or equity, will have both debit and credit entries.

When using the double entry accounting system, two things must always be balanced. The general ledger, which tracks debit and credit entries, must always be balanced. Additionally, the balance sheet, where assets minus liabilities equals equity, must also be balanced.

The examples below will clarify the rules for double entry bookkeeping:

A simple double entry bookkeeping example

Assume that a furniture company purchases $5,000 of wood for inventory and pays cash for the purchase.

Here is the journal entry, with account numbers included:

This is a simple journal entry because the entry posts one debit and one credit entry. The company should debit (increase of asset account) $5,000 from the wood in the inventory account and credit (decrease of asset account) $5,000 to the cash account. 

Because both of these accounts are asset accounts, the balance sheet equation remains in balance:

Liabilities remain unchanged at $0, and equity remains unchanged at $0.

A more complex double entry bookkeeping example

A complex journal entry means that the entry may have multiple debit and credit entries. Assume, for instance, that a furniture company purchases a $30,000 machine by paying $5,000 in cash and borrowing $25,000.

Here is the complex journal entry:

In this example, the company would debit (increase in asset account) $30,000 for the machine, credit (decrease in asset account) $5,000 in the cash account, and credit (increase in liabilities) $25,000 in a bank loan ‘accounts payable’ account. The total debit balance of $30,000 matches the total credit balance of $30,000.

This is a complex journal entry because the entry posts two credit entries, however, you can see that the balance sheet equation remains equal:

The company gains $30,000 in assets from the machine but loses $5,000 in assets from cash. This means assets are now $25,000. Liabilities are also worth $25,000, which, in this case, comes in the form of a bank loan. So, $25,000 minus $25,000 equals $0. The balance sheet equation is correct. 

In short, the accounting equation as explained here is:

Assets = Liabilities + equity 

Thus, both liabilities and equity show how the business’s assets are financed.

Verify your books with a trial balance

At any point in time, an accountant can produce a trial balance, which is a listing of each general ledger account and its current balance. The total debits and credits on the trial balance will be equal to one another. Accountants frequently review the trial balance to verify that they posted journal entries correctly within the general ledger, as well as to correct any errors.

At the end of each month and year, accountants post adjusting entries to the trial balance and use the adjusted trial balance to generate financial statements. Accounting software provides controls to ensure your trial balance is accurate. The software will ensure that the total dollar amount of debits equals the credit balance and that each account balance is in your trial balance report.

Using double entry accounting to ensure accurate record-keeping

As you can see, the entire accounting process starts with double entry bookkeeping. Whether you do your own bookkeeping with small business bookkeeping software or hire a bookkeeper, understanding this critical accounting concept is essential for the success of your small business.

If you’ve previously used a single entry accounting system, you may be wondering how to go about switching to a double entry system. Most modern accounting software has double entry concepts already built-in.

Business owners who have previously operated on a single entry accounting system will want to make the switch to a double entry accounting system as soon as possible. As your business grows, so too will the complexity of your finances. Implementing a double entry accounting system will allow you to put your financial statements to better use so that you can measure your financial health and spot errors quickly.

Can accounting software make a difference?

For a sole proprietorship, single entry accounting can be sufficient, but if you expect your business to keep growing, it’s a good idea to master double entry accounting now. Double entry accounting will allow you to have a deeper understanding of your company’s financial health, quickly catch accounting mistakes, and share a snapshot of your business with investors. With the help of accounting software, double entry accounting becomes even simpler.

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