Today’s basic accounting system is based on double entry, a 500 year old procedure dating back to the late 1400’s (in 1494, Franciscan monk and mathematician Luca Pacioli, a contemporary of Leonardo da Vinci, documented the double entry procedure quickly being adopted by Venetian merchants of his day).
Double entry accounting follows the “Golden Rule of Accounting” (namely that Equity = Assets – Liabilities), recording each financial transaction in at least two of the accounts in the bookkeeping system to keep the sum of all debits equal to the sum of all credits. T Accounts are commonly used as a way to organize your debits / credits to make sure they balance together.
The “American approach” to double entry bookkeeping is based on the classification of all accounts into five basic types: assets, liabilities, income/revenues, expenses and capital gains/losses. Accordingly, the following rules apply:
In Asset Accounts, debits increase assets and credits decrease assets; in Capital Accounts, credits increase capital and debits decrease capital; in Liabilities Accounts, credits increase liabilities and debits decrease liabilities; in Income/Revenue Accounts, credits increase income/revenue and debits decrease income/revenue; and finally, in Expense/Loss Accounts, debits increase expense/loss and credits decrease expense/loss.
Essentially, double entry accounting is just the documentation of the movement of funds from one account to another. One account is credited (added to) and another account is debited (taken from). For example, when a sale is made, the inventory held is credited (decreased) and the cash or cash receivable is debited (increased).
Another way to think of double entry bookkeeping is to consider one account as having a claim on another. For example, for every asset, there is a claim on that asset by those who own the business, finance the business, etc.
In double entry accounting, all financial transactions are recorded sequentially in a Journal as they happen. For example, if you purchased a new computer on credit on March 15th for $800, you might record it as #3 Asset Computer/Liability $800, meaning that it was the 3rd transaction entry made in the journal on the 15th of March, and the accounts affected were the Asset book and the Liability book.
It is important to note that some transactions affect only one side of the bookkeeping system, but double entry works to keep the books balanced. For example, if you pay $2,000 cash to purchase a new piece of equipment on August 17th, the only account physically affected would be the Cash account, but double entry accounting also debits $2,000 to the Asset account to keep the overall books in balance.
Once you understand the history of double entry accounting, the basic functioning of the system and the rules that apply, it will be easy to see how it has become the bookkeeping system of choice for accounts everywhere.
Stay in the loop
