The double-entry bookkeeping system is the foundation of modern accounting. It ensures that every financial transaction affects at least two accounts. This system maintains the accounting equation (Assets = Liabilities + Equity) and provides a more reliable and comprehensive view of a business's financial position.
Key Principles
Every transaction affects at least two accounts.
Debits and Credits are used to record transactions.
The accounting equation must always remain in balance.
The total of debits must always equal the total of credits.
Debits and Credits
Debits and credits are the fundamental components of the double-entry system. They represent increases and decreases in account balances. The effect of a debit or credit depends on the type of account.
Account Type
Debit (Dr)
Credit (Cr)
Assets
Increase
Decrease
Liabilities
Decrease
Increase
Equity
Decrease
Increase
Revenue
Decrease
Increase
Expenses
Increase
Decrease
Drawings
Increase
Decrease
Important Note: The effect of a debit or credit is determined by the type of account. Remember the acronym DEAD COLR: Debits increase Expenses, Assets, and Drawings. Credits increase Owners' Equity, Liabilities, and Revenue.
The Accounting Equation
The accounting equation is the core principle underlying the double-entry system. It states that a business's assets are equal to the sum of its liabilities and equity.
$$Assets = Liabilities + Equity$$
This equation must always remain in balance. Every transaction affects at least two accounts, ensuring that the equation stays in equilibrium.
Example Transaction
A business purchases equipment for $2,000 in cash.
What accounts are affected? Equipment (an asset) and Cash (an asset).
What is increasing? Equipment and Cash.
What is decreasing? Since cash is leaving the business, it is decreasing.
Debit and Credit entries:
Debit: Equipment $2,000 (Equipment is an asset, and assets increase with a debit)
Credit: Cash $2,000 (Cash is an asset, and assets decrease with a credit)
Suggested diagram: A simple illustration showing a transaction with a debit and a credit, clearly indicating the accounts affected and the direction of the entry.
Benefits of the Double-Entry System
Accuracy: The system helps to ensure that financial records are accurate by requiring two entries for every transaction.
Reliability: The system provides a more reliable view of a business's financial position.
Error Detection: The system makes it easier to detect errors in financial records.
Comprehensive View: The system provides a comprehensive view of a business's financial position.