What is Double Entry: Why Double Entry Bookkeeping is Important

Double entry bookkeeping and Accounting are important for financial figures' accuracy and are recommended by both GAAP and IFRS. Double entry bookkeeping and accounting records for both aspects of the transaction. Double entry bookkeeping provides a detailed view of a business's financial health and accurate information about business financial health.

What is a double entry? 

Evert financial transaction has two aspects and respectively hits two accounts. There is a debit and credit concept in accounting which is then applied. You have to debit one account and credit the other one. If you are wondering what debit and credit and what account should be debit and what should be credited here is the explanation to it for all classes of financial transactions.

Double entry or credit/debit for Assets:

For asset is the asset increases it becomes debit and if it decreases it becomes credit. 

Double entry or credit/debit for Liabilities:

If liability increases it becomes a credit and if liability decreases it becomes a debit.

Double entry or credit/debit for Income:

When income increases or is earned it becomes credit and vice versa

Double entry or credit/debit for Expenses:

Expenses when increased become debit and vice versa.


Example

Consider you have purchased the machinery for $1000 dollars and you paid 40% and 60% is payable after a month, and using this plant you generate 100 units which you sold for $200 $2 dollar per unit and your expenses for that week was 20 dollars here is the double entries for the given scenario:


Before going forward with the example, we need information about charts of account. The chart of accounts is the list of accounts that your categories transaction into and appear as a separate line item of financial statement/financial reports is it profit and loss or balance sheet?


Description 

debit 

credit

Machiner

1000


cash


400

Payable


600




income 


200

Misc expenses

20



The chart of accounts is the list of accounts that your categories transaction into and appear as separate line items of financial statement/financial reports are it profit and loss or balance sheet. 

Setting up a chart of accounts is a technical task depending upon the nature and industry in which the business operates.

Here are charts of accounts 

  • Assets

    • Building

    • Accounts receivable

    • Cash

    • Inventory assets

    • Petty cash balance

    • Prepaid insurance

    • Savings funds

    • Undeposited funds

    • Vehicles   

  • Liabilities

    • Accounts payable

    • Accrued liability

    • Notes payable

    • Company credit card balances

    • Payroll 

  • Owner’s equity

    • Common stock

    • Preferred stock

    • Retained earnings (accounts associated with the owner’s equity)

  • Revenue

  • Expenses

There is a famous equation in double entry accounting that the sum of equity and liability must be equal to assets which is termed the accounting equation. Double-entry bookkeeping must follow this equation: Assets = Liabilities + Equity. 

Assets include:

  • Property plant and equipment

  • Cash

  • Cash equivalents

  • certificates of deposit or Treasury bills (Liquid asset)

  • Inventory

  • Account receivable 

  • Short-term investment (cash equivalent)

Liabilities include: 

  • Debt

  • Dividends payable

  • Long-term debt

Equity is the amount that shareholders contribute initially plus/minus any retained earnings. This can also be explained as equity is the amount available to be distributed among shareholders after all assets are liquated and debts or liabilities are paid.

The retained earning refers to in the second last paragraph is the percentage of earnings that is kept under the equity section of the balance sheet and is held and not yet paid to shareholders. Retained earnings may be positive or negative. Positive retained earnings are the accumulation of profit over the periods and negative retained earnings are the accumulation of losses over the years.

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