Double-entry bookkeeping showcases the true nature of business – you can’t receive something for nothing. No matter what your business obtains, it’s because you gave something up.
This is evident across a variety of avenues in which a business can gain revenue: Sold goods? You gave up inventory. Got an investor? You gave up equity. Took a loan? You now have a debt.
Thankfully, this is common practice in any business. However, businesses can struggle to acknowledge both sides of each transaction and have it recorded. This is why double-entry bookkeeping serves as your reliable framework, ensuring all your transactions are accurately captured, balanced, and reflected in your financial records. Let’s delve into exactly how it works….
What is double-entry bookkeeping?
Double-entry bookkeeping provides you with a comprehensive view of all the knock-on effects from every business transaction and reflects them within your accounts. It is based on the accounting equation:
Assets = Liabilities + Equity
Every transaction affects this equation in such a way that it always remains balanced.
In accounting, a credit is an entry that increases a liability account or decreases an asset account, while a debit is an entry that increases an asset account or decreases a liability account. In the double-entry accounting system, transactions are recorded using both debits and credits. Because a debit in one account offsets a credit in another, the total of all debits must always equal the total of all credits.
The double-entry bookkeeping system standardises the accounting process and enhances the accuracy of financial statements, making it easier to detect errors. Every business account is recorded as either a debit or a credit, ensuring comprehensive and balanced financial records.
Debits and Credits
Debits and credits are crucial to double-entry systems. In accounting, a debit refers to an entry on the left side of an account ledger, while a credit refers to an entry on the right side. To maintain balance, the total debits and credits for a transaction must be equal. It’s important to note that debits do not always mean increases, nor do credits always mean decreases; their impact depends on the type of account involved.
A debit can increase one account while decreasing another. For instance, a debit increases asset accounts but decreases liability and equity accounts, aligning with the fundamental accounting equation: Assets = Liabilities + Equity. On the income statement, debits increase the balances of expense and loss accounts, whereas credits decrease their balances. Conversely, debits decrease revenue account balances, while credits increase them.
A simple example can be shown with your business taking a loan from the bank. If you took a loan of £10,000, the cash account (asset) increases by £10,000 (debit), and the loan account (liability) increases by £10,000 (credit).
How can we help?
We understand that each business is unique and may or may not require double-entry bookkeeping. However, this can be decided on a case-by-case basis. If you want to discuss this with our team, please contact us through our Tax Manager, Chris Barlow, at [email protected]
