Double-entry bookkeeping explained

When it comes to keeping up to date with your business finances it’s important to use a tried and true system for your financial data entry and monitoring. This gives you instant feedback on the state of your finances and enables reports to be generated to share with stakeholders. The one system that can be relied on for Australian business and is trusted and approved across the board is in fact centuries old, dating back to the merchants of Venice in the 1400s, it’s called double-entry bookkeeping.

What is double-entry bookkeeping?

Double-entry bookkeeping works on the principle of cause and effect. When you spend money (debit your account) in one area you are purchasing an asset that goes on to credit a different account in some way – thus adding value to your business – and vice versa. This means that in order to accurately record your business finances you need to add every transaction to the appropriate debit and credit lines simultaneously.

Account types

In order to make the double entry system work there need to be five accounts covered that allow ledgers to balance. These accounts are:

Asset accounts

Asset accounts that record any monetary value owned by a business which includes cash, equipment, buildings and vehicles

Liability accounts

Liability accounts record any debts or money owed. This can be immediate payments such as accounts payable, or long-term debts such as loans and mortgages.

Equity accounts 

Equity accounts show what is left over when you subtract the total liabilities from the total assets.

Revenue accounts

Revenue accounts record all the money a business earns through sales, income and dividends.

Expense accounts

Expense accounts detail every expense needed to make the business run such as advertising, travel and payroll.

Who uses double-entry bookkeeping?

Any small business that wants an accurate record of its accounts will need to use double-entry bookkeeping. This will make it easier to assess financial standings, attract investors, request loans and create financial reports.

What are the rules of double-entry bookkeeping?

Double-entry bookkeeping is based on the equation: Assets = Liabilities + Equity.

Every transaction must be listed at least twice, across two separate accounts so the ledger will always balance out at the end of the day. Accountants use the five different accounts to list debit and credit entries for each business transaction. Accountants will use the five different accounts to list debit and credit entries for each business transaction.

What are debits?

Debits will be shown on the left-hand side of the ledger and will be shown to increase an asset account and decrease a liability account (they can also decrease revenue).

What are credits?

Credits will be shown on the right-hand side of the ledger. Credits will be shown to increase revenue or liability accounts and decrease an asset account. 

Why is double-entry bookkeeping important?

In business it’s important to closely monitor income and expenses equally and understand the relationship between them. Double-entry bookkeeping has been used for centuries because it takes the full scope of business finances into account. This enables business owners and stakeholders to:

  • Deliver a complete financial picture
  • Forecast future spending
  • Make better financial decisions
  • Reduce bookkeeping errors
  • Provide reports to investors, banks and buyers

Recording your transactions accurately in the correct accounts is essential for making double-entry bookkeeping reliable and useful. Because of the complex nature of double-entry bookkeeping, it’s best to get a customised solution based on your business needs.

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