The double entry accounting system is a financial record keeping method that involves making two simultaneous entries into two separate accounts for each financial transaction. This system records both the inflow and outflow of the transaction, ensuring that the total debits and credits are balanced. By doing so, it allows business to maintain accurate financial records and assess their overall performance over a financial year.
The history of the double-entry accounting system dates back to the late Middle Ages, particularly in the 15th century. Its development is often attributed to the Italian mathematician and Franciscan friar Luca Pacioli.
The formal system of double-entry accounting was first described by Luca Pacioli in his seminal work, “Summa de Arithmetica, Geometria, Proportioni et Proportionalità,” published in 1494. Pacioli’s work included a section on bookkeeping called “Particularis de Computis et Scripturis” (Details of Calculation and Recording), which outlined the principles of double-entry bookkeeping.
Pacioli’s description of the double-entry system helped standardize accounting practices among merchants and traders in Renaissance Italy, contributing to the growth of commerce and trade in Europe.
Mechanism of the Double-Entry Accounting System
The double-entry accounting system works on the principle that for every transaction, there are at least two accounts involved: a debit and a credit. organizations about. Here’s how it operates:
- Dual Aspect: Every transaction affects at least two accounts, with one account debited and another credited. This ensures that the accounting equation (Assets = Liabilities + Equity) remains balanced.
- Debits and Credits:
► Debit: An entry on the left side of an account represents an increase in assets or expenses and a decrease in liabilities or equity.
► Credit: An entry on the right side of an account represents an increase in liabilities or equity and a decrease in assets or expenses.
Example: When a company sells a product for cash, two entries are made:
Cash (Asset) is debited (increased), and Sales (Revenue) is credited (increased). This reflects both the increase in cash (an asset) and the revenue earned (income).
Basic Principles
1. Dual Aspect Concept:
► Every transaction has two aspects: a debit and a credit.
► Each transaction affects at least two accounts, with one account being debited and the other credited.
2. Debits and Credits:
► Debit (Dr): An entry on the left side of an account.
► Credit (Cr): An entry on the right side of an account.
► Every debit entry should have an equal and consecutive credit entry.
Steps in Double-Entry Accounting
Identify the Transaction:
► Determine what transaction has occurred and what accounts are affected.
Determine the Accounts:
► Identify which accounts are impacted (e.g., cash, inventory, sales, expenses).
Classify the Accounts:
► Classify the accounts as assets, liabilities, equity, revenues, or expenses.
Apply the Double-Entry Rule:
► Decide which account to debit and which to credit, ensuring the total debits equal the total credits.
Example Transaction
Scenario:
⇒ A company sells goods worth $10,000 for cash.
Steps:
Identify the Transaction:
⇒ Sale of goods for cash.
Determine the Accounts:
⇒ Cash (Asset)
⇒ Sales Revenue (Revenue)
Classify the Accounts:
⇒ Cash is an asset account.
⇒ Sales Revenue is a revenue account.
Apply the Double-Entry Rule:
⇒ Debit the Cash account because cash is increasing.
⇒ Credit the Sales Revenue account because revenue is increasing.
Journal Entry:
Cash $10,000 Dr.
Sales Revenue $10,000 Cr.
(Sale of goods for cash)
Impact on the Accounting Equation
Assets: Cash increases by $10,000 (Debit).
Equity: Sales Revenue increases by $10,000 (Credit), which contributes to equity through retained earnings.
The accounting equation remains balanced because the increase in assets is matched by an increase in equity.
More Resources
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