As your business grows, your bookkeeping responsibilities become more complex. Painting a complete picture of your financial health now means accounting for transactions single-entry accounting systems cannot accommodate, such as assets, liabilities, and equity.
A system like double-entry bookkeeping will help you track where money flows, ensuring enhanced bookkeeping accuracy and tighter fraud prevention. In this article, we take a closer look at:
- What double-entry bookkeeping is
- The differences between double-entry and single-entry bookkeeping
- The different types of business accounts and how debits and credits impact them
- Double-entry bookkeeping steps
What is Double Entry Bookkeeping?
Double-entry bookkeeping, also known as double-entry accounting, is a type of bookkeeping system that records two sides to every financial transaction: a debit side and a credit side. Each side represents the direction in which money flows into your business, with debits representing money flowing in and credits representing money flowing out.
For every debit, there is an equal and opposite credit. Following this principle when recording transactions ensures that your books stay balanced.
Double-entry bookkeeping is also characterized by its use of accounts. Instead of just tracking revenue and expenses, it also monitors assets, liabilities, and equity. At the end of the accounting period, you use the recorded information to prepare financial statements like balance sheets and income statements.
Single Entry vs. Double Entry Bookkeeping
The best way to illustrate the double-entry system is to contrast it with single-entry accounting. While single-entry accounting is a valid system for recording transactions, it fails to accommodate more complex types of accounts, such as assets, liabilities, and equity.
Single-Entry System
Traditionally, businesses only needed to track income and expenses. The single-entry accounting system reflects this simplicity. The system, which uses cash books to track transactions, requires only four balance columns: date, description, income, expenses, and bank balance.
Each transaction would be categorized as either income or expense and then take up one line of the sheet. You would then add or subtract the transaction amount to the bank balance at the end of the line. Naturally, you add income and subtract expenses.
Below is an example of a simple single-entry cash book.
| Date | Description | Income | Expense | Bank Balance |
| XX-XX-XXXX | Starting Balance | $5,000 | $5,000 | |
| XX-XX-XXXX | 25 Items Purchased | $2,000 | $3,000 | |
| XX-XX-XXXX | 10 Items Sold | $1,500 | $4,500 | |
| XX-XX-XXXX | Rent | $600 | $3,900 | |
| XX-XX-XXXX | Electricity | $50 | $3,850 | |
| XX-XX-XXXX | Ending balance | $6,500 | $2,650 | $3,850 |
Double-Entry System
The trouble with single-entry accounting is that keeping track of transactions like debt and investments gets confusing. It also doesn’t account for the value of your assets, such as property, equipment, and inventory.
Double-entry bookkeeping remedies the limitations of single-entry bookkeeping by using five primary account types: assets, expenses, liabilities, equity, and revenue.
Instead of representing each transaction as either income or expense, double-entry bookkeeping splits transactions into two parts: a debit to one type of account and a credit to a different account. This shows how value flows through the business.
Let’s represent the previous example using double-entry bookkeeping journal entries.
| Date | Description | Debit | Credit |
| XX-XX-XXXX | Cash (Asset) | $2,000 | |
| XX-XX-XXXX | Loan Account (Liabilities) | $2,000 | |
| XX-XX-XXXX | Cash (Asset) | $3,000 | |
| XX-XX-XXXX | Owner’s Equity (Equity) | $3,000 | |
| XX-XX-XXXX | Purchase Inventory – 25 Items (Asset) | $2,000 | |
| XX-XX-XXXX | Accounts Payable (Liability) | $2,000 | |
| XX-XX-XXXX | Accounts Receivable (Asset) | $1,500 | |
| XX-XX-XXXX | Sales Revenue – 10 Items (Revenue) | $1,500 | |
| XX-XX-XXXX | Cost of Goods Sold – 10 Items (Expense) | $800 | |
| XX-XX-XXXX | Inventory Sold – 10 Items (Asset) | $800 | |
| XX-XX-XXXX | Rent Expense (Expense) | $600 | |
| XX-XX-XXXX | Cash (Asset) | $600 | |
| XX-XX-XXXX | Electricity Expense (Expense) | $50 | |
| XX-XX-XXXX | Cash (Asset) | $50 |
As shown above, the system gives you more flexibility to account for amounts you’ve yet to pay for and amounts you’ve yet to receive. It also lets you account for the value of your inventory.
Unlike single-entry systems, double-entry systems don’t aim to provide updated ending bank balances in real time. Instead, the system’s goal is to monitor both sides of a transaction while helping gather data for financial statements such as income statements (which track revenue) and balance sheets (which provide the total value of your assets, liabilities, and equity.)
Types of Accounts in Double Entry Bookkeeping
The main feature that sets double-entry accounting apart from single-entry bookkeeping is the use of different accounts. Where single-entry accounting only shows income, double-entry bookkeeping shows your business’ value in assets, equity, and revenue while also reflecting money spent on liabilities and expenses.
Assets
Assets refer to resources that your business owns or controls. These resources are characterized by the ability to provide future or current financial benefits through activities like revenue generation, sales optimization, or expense reduction. Examples include cash, inventory, property, equipment, and even copyrighted materials.
You can classify assets by convertibility (current or fixed), tangibility (tangible or intangible), or usage (operating or non-operating).
- Current assets are resources the company expects to consume or liquidate in the short term. Examples include cash, accounts receivable, inventory, and office supplies.
- Fixed assets are assets acquired for long-term use. They are typically difficult to liquidate. Examples include land, machinery, and trademarks.
- Tangible assets physically exist and provide economic value. Examples include inventory, supplies, and equipment.
- Intangible assets have no physical form but contribute to the company’s economic benefit. Examples include copyrights, trademarks, licenses, and patents.
- Operating assets directly contribute to the business’ core activities. Examples include cash, inventory, and equipment.
- Non-operating assets generate revenue without being related to core business activities. Examples include short-term investments, unused land, and interest from deposit accounts.
Expenses
Expenses are costs incurred to operate the business. Expenses differ from assets because the business does not fully own or control the resources contributing to economic activity.
There are two main categories of expenses: operating and non-operating.
- Like operating assets, operating expenses directly contribute to core business activities. Examples include rent, employee salaries, and cost of goods sold.
- Non-operating expenses come from sources outside the business’s day-to-day activities. This includes depreciation, inventory write-offs, and loan interest payments.
Liabilities
Liabilities track everything the business owes to third parties. They represent financial obligations that the business has yet to pay, including accounts payable, credit card debt, and loans.
Liabilities are typically classified by temporality. Current liabilities are due in the short term, while non-current liabilities are due in the long term.
- Current liabilities are short-term debts the business expects to pay within the year. Examples include accounts payable, interest payable, wages payable, and unearned revenue.
- Non-current liabilities are withstanding debts the business expects to pay in more than a year. Examples include loans, lines of credit, and post-employment benefits.
Equity
Equity is the total amount of money owners and/or shareholders invest in a business. It represents the cash value of the business after liquidating all assets and paying off all debt. Examples of equity include the following:
- Owner’s capital
- Common stock
- Preferred stock
- Treasury stock
- Retained earnings
- Contributed surplus
Revenue
Revenue is the value the business generates from its core and non-core activities.
It’s easy to confuse revenue with cash or assets. However, revenue accounts don’t represent the money your business actually has. Instead, it reflects earnings that have yet to be liquidated or used.
Like expenses, revenue can be classified as operating or non-operating depending on the transaction’s relation to core business activities.
- Operating revenue comes from the business’ main activities. Examples include sales revenue for sales-based businesses, service revenue for service-based business, and rental revenue for landlords.
- Non-operating revenue comes from sources unrelated to the business’ core activities. Examples include deposit account interest, dividend income, and currency fluctuations.
Debits and Credits in Double Entry Bookkeeping
As mentioned above, the rule of recording transactions in double-entry accounting is that each transaction should have an equal and opposite amount in a different account. These transactions are called debits and credits. We refer to transactions that place money into the business as debits and transactions that place money outside the business as credits.
Debits
Debits represent transactions that place money into the business’ resources and activities. You record debits on the left side of a journal entry.
As a rule, debit transactions increase asset and expense balances. In turn, they decrease liability, equity, and revenue balances.
Credits
Credits represent transactions that move money from the business to a source of economic benefit. You record credits on the right side of a journal entry.
In the reverse of debits, credit transactions increase liability, equity, and revenue balances while decreasing liability, revenue, and equity balances.
The Accounting Equation in Double Entry Bookkeeping
The principle underlying double-entry accounting is that assets are equal to liabilities plus equity. This is the basis of the accounting equation, which we’ve written below.
| Assets = Liabilities + Equity |
To put it in more concrete terms, the value of everything your business owns comes from your debt to third parties and investments from shareholders.
You can also expand the equation to include dividends, expenses, and revenue.
| Assets = Liabilities + Equity + Revenue – Expenses – Dividends |
This means that the value of everything your business owns comes from the value it generates, plus the value shareholders have invested, plus debts to third parties, minus expenses and dividends. Note that dividends are not typically included in the primary account types and instead recorded under liabilities or reductions in equity.
Modifying the equation to make all variables positive gives you this result.
| Assets + Expenses + Dividends = Liabilities + Equity + Revenue |
This explains why assets and expenses increase with debits, and liabilities, equity, and revenue increase with credits. One side represents value flowing into the business, while its opposite represents value flowing to outside sources.
Double Entry Bookkeeping Steps
Double-entry bookkeeping is more than just recording entries on a ledger. Follow the steps below to ensure the accuracy of your documents, books, and financial statements.
Create a Chart of Accounts
To keep your finances organized, it’s best to create a chart of accounts. This document is a categorized index of all accounts you will record on the general ledger.
Each entry on your chart of accounts will provide the following information:
- Account identification code: A unique number assigned to the account.
- Description: What the account represents.
- Account type: Whether the account is considered an asset, expense, liability, equity, or revenue.
- Corresponding financial statement: Which financial statement the account appears in. Expense and revenue accounts appear in income statements, while assets, liabilities, and equity appear in balance sheets.
Let’s expand on the example we used in the single-entry vs double-entry system section.
| Number | Description | Account Type | Financial Statement |
| 1-01 | Cash | Asset | Balance sheet |
| 1-02 | Accounts Receivable | Asset | Balance sheet |
| 1-03 | Inventory | Asset | Balance sheet |
| 2-01 | Accounts Payable | Liability | Balance sheet |
| 2-02 | Loan Account | Liability | Balance sheet |
| 3-01 | Owner’s Equity | Equity | Balance sheet |
| 3-02 | Retained Earnings | Equity | Balance sheet |
| 4-01 | Sales Revenue | Revenue | Income statement |
| 5-01 | Cost of Goods Sold | Expense | Income statement |
| 5-02 | Electricity Expense | Expense | Income statement |
| 5-03 | Rent Expense | Expense | Income statement |
The document makes tracking your different account types easier. It also helps you easily determine which types of accounts correspond with which financial statements.
Save Accounting Source Documents
Double-entry bookkeeping is difficult without a system for tracking transactions. While your bank account or credit card will typically track expenses and income automatically, it’s best practice to save any accounting source documents that come your way. These include:
- Receipts
- Sales and purchase invoices
- Orders
- Quotes
- Credit and debit notes
- Cheques
- Deposit slips
Not all accounting source documents need to be physical. Many modern businesses provide electronic invoices, receipts, and even cheques. However, you need to ensure that your documents contain the following information:
- Transaction date
- Transaction amount
- Transaction description
- Authorizing signatures
Saving your transactions’ paper trail helps you quickly locate all critical information for the journal entries you record on your ledger. It ensures accuracy and ease of recording.
Record Transactions on Journal Entries
Record each financial event as a journal entry on your general ledger. Refer to your receipts and chart of accounts to determine which two account types will be affected and which account will account as a debit or credit. Let’s draw examples from the scenario above.
- Owner’s Equity
You deposit $3,000 into your business bank account. You record this as a debit to your cash account, which is an asset. Since the money came from an investor (you), you would record the same amount as a credit to equity.
| Date | Description | Debit | Credit |
| XX-XX-XXXX | Cash (Asset) | $3,000 | |
| XX-XX-XXXX | Owner’s Equity (Equity) | $3,000 |
- Purchasing Inventory
You purchase 25 items worth $80 each on credit. The total inventory is worth $2,000 and counts as an asset. Since you have yet to pay the amount, you will add the Accounts Payable as liability credit.
| XX-XX-XXXX | Purchase Inventory – 25 Items (Asset) | $2,000 | |
| XX-XX-XXXX | Accounts Payable (Liability) | $2,000 |
- Selling Inventory
You sell your inventory for $150 per item. A customer orders 10 of the same item, earning you $1,500 in revenue. You record revenue in the credit column and accounts receivable in the debit column.
However, you would also need to account for the cost of goods sold and the loss in inventory. Since each item cost $80, and you sold 10, you would record the cost of goods sold as a $800 expense debit and inventory as an equivalent asset credit.
| Date | Description | Debit | Credit |
| XX-XX-XXXX | Accounts Receivable (Asset) | $1,500 | |
| XX-XX-XXXX | Sales Revenue – 10 Items (Revenue) | $1,500 | |
| XX-XX-XXXX | Cost of Goods Sold – 10 Items (Expense) | $800 | |
| XX-XX-XXXX | Inventory Sold – 10 Items (Asset) | $800 |
Ensure Accuracy with a Trial Balance
Before preparing your financial statements, create a trial balance to ensure that your debit and credit columns match each other. Discrepancies in totals help you spot any errors in recording.
A trial balance typically consists of three columns. The first column lists all account types in your general ledger, while the next two list debits and credits.
Get the sum of all entries that correspond to the same account. Using our recurring example, your cash total would be $2,000 + $3,000 – $600 – $50, which equals $4,350. Meanwhile, your inventory total would be $2,000 – $800.
Record the total of each account under either the debit or credit column. If the account is an asset or expense, the total should appear on the debit column. Meanwhile, if the account falls under liability, equity, or revenue, you should record the total on the credit column.
| Accounts | Debit | Credit |
| Cash (Asset) | $4,350 | |
| Accounts Receivable (Asset) | $1,500 | |
| Inventory (Asset) | $1,200 | |
| Accounts Payable (Liability) | $2,000 | |
| Loan Account (Liability) | $2,000 | |
| Owner’s Equity (Equity) | $3,000 | |
| Sales Revenue (Revenue) | $1,500 | |
| Cost of Goods Sold – 10 Items (Expense) | $800 | |
| Rent Expense (Expense) | $600 | |
| Electricity Expense (Expense) | $50 | |
| Totals | $8,500 | $8,500 |
Finally, add up the totals of each column to see if they’re equal.
Prepare an Income Statement
Now that you know your records are accurate, use the entries to prepare your income statement. This financial statement tracks the company’s revenue and expenses to show profit and loss over a selected period of time.
Your income statement should include the following:
- Gross sales: Your total revenue before expenses.
- Cost of goods sold: The cost of producing your products or services.
- Gross income: Also known as gross profit, gross income is your revenue minus cost of goods sold.
- Operating expenses: The cost of running your business.
- Operating income: Your gross income less operating expenses.
- Tax expenses: The amount the business owes in tax.
- Net income: Total income minus expenses and taxes.
We’ll illustrate how an income statement might look using our recurring example. For simplicity’s sake, we’ll exclude taxes.
| Revenue | |
| Sales Revenue | $1,500 |
| Total Revenue | $1,500 |
| Cost of Goods Sold | |
| Materials | $800 |
| Total Cost of Goods Sold | $800 |
| Operating Expenses | |
| Rent | $600 |
| Electricity | $50 |
| Total Operating Expenses | $650 |
| Income | |
| Gross Sales | $1,500 |
| -$800 | |
| Gross Income | $700 |
| -$650 | |
| Operating Income | $50 |
| Net Income | $50 |
Your income statement helps you clearly understand how much you’re spending, how much you’re earning, and how profitable your business model is.
Prepare a Balance Sheet
The final step in double-entry bookkeeping is preparing a balance sheet. This financial statement reflects the book value of your assets, liabilities, and equity. As per the accounting equation, your total assets should equal your total liabilities and equity.
To prepare your balance sheet, refer to the account totals in your trial balance, then separate accounts by account type. Add up your total assets, total liabilities, and total equity.
In this example, we’ll add $50 in retained earnings to equity based on your net income from your income statement. This nets you $7,050 for assets and $7,050 for liabilities and equity.
| Assets | |
| Cash | $4,350 |
| Accounts Receivable | $1,500 |
| Inventory | $1,200 |
| Total Assets | $7,050 |
| Liabilities and Shareholder’s Equity | |
| Accounts Payable | $2,000 |
| Loan Account | $2,000 |
| Owner’s Equity | $3,000 |
| Retained Earnings | $50 |
| Total Liabilities and Shareholder’s Equity | $7,050 |
Start Your Double Entry Bookkeeping Journey with EpicBooks
While single-entry bookkeeping is an effective tool for tracking income, expenses, and balances, it cannot paint a complete picture of your business’ financial health. With double-entry bookkeeping, you also get to track how much your assets are worth, how much you owe, and your total equity. Its two-line recording system also helps you spot errors faster, ensuring greater recording accuracy.
As a business owner, your primary focus should be impactful, sales-generating business activities. Unburden yourself from the manual load of double-entry bookkeeping by outsourcing the financial management to EpicBooks’ professionals. Not only do we keep accurate books, but we also help you manage payroll, prepare for taxes, create optimized budgets, and generate strategic financial insights.
Read the EpicBooks services page for more information!
