Accounting plays the pivotal role to the financial management because it helps them to record as well as report the financial activities. Accounting mechanical and at the center of modern accounting is the double entry system and the accounting equation.
These basics guarantee precision, dependability, and scope in summarizing the condition of financial affairs.
In this article, the writer expounds on the nature of double-entry accounting; its origin, the constituents, significance and usage supplemented with examples of its operation.
The role of Double-Entry Accounting implies the definition of what this concept is all about.
Double-entry accounting is a recording technique of business transactions under which every transaction has at least two effects – debit and credit. This double impact makes sure that the accounting formula; Assets =Liabilities + Equity always maintains balance.
The fundamental policy governing the double entry book keeping system is the timeless saying, ‘debits must equal credits. Debits and credits are the fundamental tools used to record changes in accounts:
- Debit (Dr.): An entry which depicts an addition to the asset side and/or a reduction of the liability side, equity side or revenue side of the Partners’ Company.
- Credit (Cr.): An entry that results in a decrease in assets or expenses, while at the same time, increases liabilities, equity, or revenue.
The Account of Double-Entry System
The historical account of double-entry accounting has been attributed to the period of reformation of Italy, the renaissance period. Double-entry bookkeeping can be attributed to a Franciscan monk and mathematician, Luca Pacioli who wrote a book in 1494 named Summa de Arithmetica, Geometria, Proportioni et Proportionalità. The methods in accounting that Pacioli introduced include journals, ledgers, and the balancing of accounts among others that existed even in the world of commerce today.
Prior to Pacioli, it is true that there were rudimentary systems of documentation but then they were not as refined or as accurate as the double entry book keeping process. Pacioli introducedistarithmetic that was to transform commerce as merchants and other businesses could now tally and record their accounts.
The Accounting Equation: Foundation of Double-Entry
Double-entry accounting is based on the accounting equation. It represents the relationship between an entity’s resources (assets) and the claims on those resources (liabilities and equity):
Parts of the Accounting Equation
- Assets: Assets controlled by the business but which are in the process of being utilized up for generating revenue, including cash, inventories, tangible property, and equipment.
- Liabilities: Liabilities include trade, bank borrowings, bills, accounts, and other amounts owed due at some time in the future.
- Equity: The interest in the total assets after eliminating the liabilities. This is other than capital subscription, earnings retention and other reserve.
The equation guarantees that each financial processes have a stable financial status. For instance, buying equipment for cash mean that cash account will decrease (asset) and equipment account (additional asset) will increase to balance the equation.
Trade-Off between Right and Accurate Measurement
- Accuracy: The transactions in two accounts facilitate identification of errors without having to go through large ledgers.
- Comprehensiveness: It gives a pro forma view of the financial health of a business enterprise.
- Auditability: The system is also easy to audit because it leaves a clean trail that can be used in auditing of the financial records.
- Compliance: Almost all the existing and emerging laws governing the regulation and presentation of financial information demand double-entry accounting.
- Decision-Making: Financial information is paramount in the development of a business strategy, and planning and determination of where to invest.
- A brief description of how double-entry accounting does work.
Double-entry accounting requires the following steps
- Identify the Transaction: Be able to identify whether the transaction is agency, expense, income, or none of the other three.
- Classify Accounts: Determine which accounts are involved (Either assets, liabilities equity, revenues, or expenses).
- Record Debits and Credits: Make the right debits and credits on the accounts.
- Ensure Balance: Ensure total debits coincide with total credits in an accounting period to balance the accounting equation.
Example 1: Purchasing Office Supplies
A business buys office stationeries worth, 500 on credit basis.
- Debit: Office supplies which is an asset goes up by $500.
- Credit: Accounts Payable (Liability) $500 (increase).
Example 2: Is it acceptable to receive Cash from a Customer
One of the services that common customers spend $1000 on.
- Debit: Cash (Asset) is up by $1,000.
- Credit: Revenue (Equity) rises by $1,000.
Practical Application: Most importantly, let us examine how to calculate financial position
What makes double entry system work is that businesses’ financial position can be ascertained at any point in time by evaluating business accounts in light of the accounting equation. Consider the following example:
Example:
Transaction 1: A company begins a financial period with $10000 as the owner’s initial investment in the business.
- Debit: Cash (Asset) $10,000.
- Credit: Owners’ Capital (Capital) $5000 Owners’ Investment (Investment) $5000 Owner’s Equity (Stock) $10000.
Transaction 2: The company pays $4,000 for equipment.
- Debit: Equipment (Asset) $4,000.
- Credit: Cash (Asset) $4,000.
Transaction 3: The organization borrows $5,000 through a loan.
- Debit: Cash (Asset) $5,000.
- Credit: Loan payable – liability $5,000.
Resulting Financial Position
- Assets: The total of business assets is equal to cash ($11,000) plus equipment ($4,000) equaling to $15,000.
- Liabilities: Loan Payable = $5,000
- Equity: Owner’s Equity = $10,000
The accounting equation remains balanced:
- Main strengths of the double entry accounting system and possible weaknesses.
Advantages
- Error Detection: There are internal controls which minimize mistakes.
- Comprehensive Records: Accounts for all the processes that occur in financial and economic activities.
- Scalability: Applies to business of any size and type.
- Regulatory Compliance: Adheres to legal parameters and requirement of financial reporting.
Disadvantages
- Complexity: But they take more time than the single-entry systems.
- Cost: These need professional staff or an efficient accounting program in place.
Different Approaches to Changes of Double-Entry Accounting in the Context of the Digitalized Society
In the past people used log books and journals to record financial transactions, with development of technology, double entry accounting has become computerized. Using these tools reduces the amount of actual hand calculations and valve financial statements and contract compliance are also checked through these tools. Some of the most used software include QuickBooks, Xero, SAP among others.
Conclusion
The double-entry accounting system and the accounting equation are valuable as unreplaceable mechanisms in the field of finance. These give a stable structure for keeping documentations of financial flows and presenting them.
the principles assists businesses to maintain their financial integrity, make the right decisions and follow the law of the land; As small business or financial personnel, these concepts should be easier to understand to ensure one will be useful in the business world in the future.
FAQ
1. What is Double Entry Accounting?
Double entry is the accounting principle which states that there should always be at least one debit account with another one to be credited account balance. This account gives equality equation where total amount in the debit equals total amount in the credits.
2. What is a Double Entry System?
This is known as a double entry system of accounts. In such a system, one account is affected and debited while the other account is affected and credited, one for another. Such a system is always in balance according to the accounting equation. The accounting equation is stated as follows.
Assets = Liabilities + Equity.
It is a system that requires every debit entry to be offset by an offsetting credit entry, and this is because sound financial statements require that the same.
3. How many entries are present in a double entry accounting system?
In double entry accounting system two types of entries are given while recording the transaction, namely debit entry and credit entry. The debit entry should equal with the total of the credits. Because of which accounting records would always remain balanced. Accounting equation remains in balance as well.
4. What is Double Entry Book Keeping?
The recording of financial transactions which has the characteristic of such that every recorded transaction is supported by a debit entry in one account and by a credit entry in another. The basic principle of accounting is everything equals to and opposite, so its accounting records are accurate as well as balanced.
5. Accounting Equation?
Accounting equation describes the relationship of a firm’s assets, its liabilities, and its equity. It can be expressed as follows:
Assets = Liabilities + Equity This is the equation for double-entry bookkeeping, and thus, this one balances the balance sheet of the company at all times. This is so because the sum total of liabilities and shareholders’ equity matches the value of assets for the company.