What is double entry accounting?
Double entry accounting or double entry bookkeeping can be explained in several ways.
Perhaps the easiest way to explain double entry accounting is to say that every debit
needs a credit.
When making accounting journal entries, the debits go on the left and the credits go on
the right.
Another way of describing double entry accounting is: both sides of the journal entry need to
be recorded.
As a lot of journal entries simply have one debit and one credit, in most cases this is
a correct statement.
An example is shown here: you receive an invoice for $800 worth of outside services.
One leg of the entry (the debit) goes to outside service expense, the other leg of the entry
(the credit) goes to Accounts Payable.
Technically speaking, “The sum of the debit entries needs to equal the sum of the credit
entries” would be a better way of describing double entry accounting.
Here’s a summary example of a more complex journal entry recording the large acquisition
of a company.
There are three debits and two credits in this journal entry.
Let’s check whether the sum of the debit entries equals the sum of the credit entries.
The sum of the amounts in the debit entries is $5.7 billion debit + $7.9 billion debit
+ $16.8 billion debit = $30.4 billion debit.
The sum of the amounts in the credit entries is $3.4 billion credit + $27 billion credit
= $30.4 billion credit.
The sum of the debit entries equals the sum of the credit entries!
Here are some more ways of describing double entry accounting.
There are always two (or more) entries for every transaction.
Every business transaction will involve two accounts (or more).
Always comply with the accounting equation: Assets = Liabilities + Equity.
Let’s dive into that last description of double entry accounting a little bit deeper.
Why do Assets need to equal Liabilities and Equity?
Well, at the end of the accounting period, you will be making a balance sheet, an overview
of what you own and what you owe, and as the name balance sheet suggests the sum of the
amounts on the left has to equal the sum of the amounts on the right.
This also means that on the journal entry level any increase in one element of the accounting
equation has to be offset by an increase in another element.
Assets increase with a debit.
Liabilities and equity increase with a credit.
Let’s check that for the acquisition journal entry that we saw before.
We first classify the accounts as Assets (A) or Liabilities (L).
There are 4 Asset accounts involved in this journal entry, and one Liability account.
The increase in the Assets accounts is $5.7 billion debit + $7.9 billion debit + $16.8
billion debit - $27 billion credit = $3.4 billion.
The increase in the Liability account is also $3.4 billion.
So this journal entry complies with the accounting equation Assets = Liabilities + Equity.
What about the other example of outside service expenses?
In this example, it is very clear that recording the invoice increases Accounts Payable, which
is a Liability.
But what about the outside service expenses, which is a debit in the income statement?
Remember that at year-end, a profit gets added to Equity,
and a loss gets subtracted from Equity.
So this journal entry also complies with the accounting equation, as Liabilities go up
and Equity goes down.
So is it ever possible to post a journal entry that is not balanced?
Well, yes and no!
But that’s a topic for a different video: suspense accounts.
There are several ways to explain double entry accounting.
I hope that one or more of these explanations resonates with you!
I hope you enjoyed this short explanation of double entry accounting.
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