What is double-entry accounting?

Proper bookkeeping is an unavoidable task when running a small business, but learning how to keep accounts as a business owner can be stressful. That’s why we’ve designed this simple, easy-to-understand guide on double-entry accounting.

A double-entry bookkeeping system might seem daunting at first, but it’s all about debits and credits and ensuring there’s a balance–hence the phrase ‘balance the books’. It’s a powerful accounting tool when employed correctly.

At Startups, we’ve been advising small businesses on financial matters for 25 years, and we’re here to help you demystify confusing concepts. We’ll talk you through what double-entry accounting is, why it’s used, and if it’s right for your particular business.

What is double-entry accounting?

Double-entry accounting is the gold standard bookkeeping system for most businesses. It’s a type of bookkeeping where two accounting entries are created for each business transaction. So, each transaction can be found in two different places in your records.

A transaction is recorded once as a debit and once as a credit. The amount recorded as a debit must be equal to the amount recorded as a credit.

It gives you a clearer and more comprehensive view of your finances, and also helps prevent fraud.

This type of detailed accounting is particularly helpful for creating your profit & loss sheet: a document created alongside a cash flow forecast and balance sheet.

What’s the difference between double-entry and single-entry accounting?

Single-entry is a much more basic, cash-based system. While double-entry takes into account debits and credits, single-entry does not. There’s only one entry per transaction, and it’s easier to maintain.

Sole practitioners and small businesses prefer single-entry for its simplicity. It’s primarily used for tracking income and expenses, while double-entry bookkeeping can be used to track assets, liabilities, equity, income, and expenses.

A key difference to note is that single-entry accounting cannot help you produce a balance sheet. It’s also far less adept at spotting errors in bookkeeping.

This is why single-entry is only really used by freelancers and very small businesses. It can be helpful for simply filing a self-assessment tax return. Although more complex, double-entry is far more reliable and gives a much more sophisticated look into your financials.

Key accounting terminology defined

Before we go into detail on how double-entry accounting works, there are some key terms you’ll need to understand:

Assets are everything that your company owns that has value, including the money in your business account, inventory, buildings, and equipment.

Liabilities are what your company owes to other entities, such as debts and obligations. Examples include a bank business loan used to set up the company or an outstanding payment to vendors for goods or services received.

Equity is what you are left with after subtracting your liabilities from your assets. It represents the net value for owners and shareholders, and it’s used as an indicator of the business’s financial health and an investment tool.

Credits and debits are financial entries which represent debit and credit transactions within a financial account. Debits can result in an increase in assets or a decrease in liabilities. Credits function as the opposite; they will subtract from assets while adding to liabilities.

Revenue refers to all the money that comes into your business. The most common example is selling products or services in exchange for money, but it can also include interest from investments or rent from a property.

Expenses refer to the costs incurred by running a business in order for the company to generate revenue, such as rent, utilities, and office supplies.

A ledger acts as a record of all your business’s financial transactions. This includes the five main types: assets, liabilities, equity, revenue, and expenses.

How does double-entry accounting work?

The important thing to remember when trying to get your head around double-entry bookkeeping: debits and credits should always be of equal value. If they’re mismatched, that’s how you know there’s an error.

If you’re feeling confused, remember the fundamental equation:

• Assets = Liabilities + Equity

You can jump back up to our terminology section if you’re not sure what any of the individual terms refer to. The key here is balance; if a transaction increases the value of one account, then the other must decrease by an equal amount.

Ultimately, there are two sides to every story, and in double-entry bookkeeping, there are two sides to every transaction. These sides are the debit and the credit recorded in your chart of accounts. There are five main types of accounts:

• Assets
• Liabilities
• Equity
• Revenue
• Expenses

A chart of accounts contains the main accounts, as well as all their subcategories, allowing you to track your transactions and ensure they’re being recorded in the correct place. You can use accounting software to help set up and automate your chart of accounts.

When you record a transaction for double-entry accounting, you must place it in the chart of accounts category that makes the most sense. Then, you will need to understand what effect that transaction had and record that.

Here’s a step-by-step of how the process should work from start to finish.

1. Record the transaction in the appropriate journal in your chart of accounts (e.g. expenses, loans, your bank account, etc.).
2. You will need to record a credit in the appropriate journal in the left column of your ledger.
3. Record a corresponding debit into another journal on the right side of your ledger.
4. Create a summary of these account balances in your general ledger.
5. Use that information to generate a balance report.
6. If the balance is correct, then you’ve used the double-entry system correctly.

Just remember, there isn’t necessarily always only two entries per transaction; this is just the minimum. There may be more entries depending on the complexity of your transaction.

An example of double-entry accounting in action

Let’s put this into a simple, real-world scenario.

You need to buy a printer for your business, so you go to the shop and purchase one with cash taken from the business’s bank account. The new printer costs £300.

When it comes time to record this in your books, you make two entries into your ledger:

• An asset account (the printer) is debited for £300 (an increase).
• And another asset account (the cash you used to pay for the printer) is credited for £300 (a decrease).

Which accounting systems use double-entry?

The best way to stay on top of your bookkeeping is to use the best accounting software.

Many of the top accounting software options support double-entry bookkeeping and can automate the process.

January is coming up quickly, so now is the best time to get to grips with your accounting software to stay on top of the accounting reference date. Here are our six top recommendations:

• Zoho Books
• QuickBooks
• Sage
• Xero
• FreeAgent
• FreshBooks

Summary

Single-entry accounting is much simpler but should only be used by sole traders and smaller businesses. Double-entry accounting is far more reliable at spotting errors, giving you a more detailed look at your finances, and can be used to create a balance sheet.

This is why it’s favoured by larger and more complex businesses that want a sophisticated look into their company’s financial health. Remember, a double-entry system is all about finding the balance: if your credits and debits don’t match up, something’s gone awry. Next, make your bookkeeping all the easier by choosing the right accountant for your business.