Double Entry Bookkeeping - What is it?

A controlled method for recording financial transactions - Music to an accountant's ear!

> Accounting Dictionary   > What is Double Entry Bookkeeping


Luca Pacioli (1447-1517) deserves some credit.

In the glitzy world of 15th Century accounting he was an A-List Celebrity.

No, not because he taught Leonardo da Vinci mathematics. (Leonardo who?)

It was because, more importantly, he wrote the first book about about double-entry bookkeeping (that's more like it).

No surprise then that he 's regarded as the Daddy of Double Entry - and in beancounting circles it doesn't get much better than that!


1. What is Double Entry Bookkeeping?

Double entry bookkeeping is a systemmatic and controlled method of recording financial transactions and a fundamental principle of accounting.

It is called double entry because every transaction is recorded as both Debits and Credits (ie. is double-sided)

For any one transaction there may be more than one Debit and more than one Credit but...

the Value of Debits must equal the Value of Credits:-

Debits = Credits

Indeed most modern accounting systems will not allow a transaction (journal) to be created if Debits do not equal Credits.

Debits and credits of similar types are recorded in Accounts held in Ledgers ('the books' of old). Where the sum of debits is greater than credits, an account is said to have a 'Debit balance', and if vice versa, a 'Credit balance'.

Logically then,

the sum of Debit Balances must equal the sum of Credit Balances!

A list of all these Debit and Credit balances is called a Trial Balance.

Double entry accounting also underpins the Accounting Equation:

Assets (Debits) = Liabilities (Credits) + Equity (Credits)

It is this self-checking control mechanism ensuring that is one of the great strengths of Double Entry Accounting.

Aaahhh. It's music to an accountant's ears...


2. What are 'Debits' and 'Credits'?

DEBIT (Dr.):  The word 'Debit' comes form Latin and means 'something owed' - similar to the word 'debt' of 'debtor'.

CREDIT (Cr.):  'Credit' again from Latin 'believe, trust' or to have credibility.

Convention has it that Debits are shown on the left of an accounting schedule or statement, Credits on the right.


3. Concept of Double Entry

Double entry works on the basis that each 'set of books' stands alone in its own right.

The bookkeeper or accountant then needs to stand in the shoes of those books to get the right perspective. Perspective is vital (see item 5 below about Bank Statements).

Double entry also assumes that nothing is given for free and that there are 2 sides to every coin - a 'giver' and a 'receiver'.  

Every financial transaction has a value and that value comes from somewhere or someone (a Credit) and is represented by something of value (a Debit).

As an example,  an entrepreneur starting a business and investing Cash or 'capital'. The business receives value as Cash. That cash or value is owed by the business to the owner.  Double entry must show both sides of this transaction:

Debit

Credit

Cash a/c

Owner's equity (Capital) a/c

Now the business has cash it will use that cash to try and earn a profit - for the owner.

So let's say the cash is converted in to a machine to make goods to sell. This is a transfer in value from one asset - cash - (so a credit) to another asset - a machine  (the debit). The double entry is:

Debit

Credit

Machine a/c

Cash a/c

And when the Goods start selling, any profit (which is more cash) will be owed back to the Owner as his or her reward. 

The end result of the double entry recording that profit is essentially:

Debit

Credit

Cash a/c

Owner's Equity (Capital) a/c

In short, the Double Entry accounting is following the movement of value around the business.

Simple!


4. Types of Debit and Credit Accounts

DEBIT Balances (Dr.):  On the Balance Sheet, debit balances will comprise Assets - Fixed Assets like Machines and Vehicles; Current Assets like Cash and Debtors.

As these assets get 'used' their value gets released - or transferred - as costs and expenses to the Profit and Loss Account (Income Statement). 

These accounts therefore also have debit balances.

CREDIT (Cr.):  On the Balance Sheet credit balances will comprise Liabilities like Trade Creditors and Loans - money owed to lenders / funders who are not the owners.

Credit balances will also include the Owner/s capital / investment (eg. shareholders) and these are categorised seperately.

For worked examples of typical financial transactions, see our practical double entry bookkeeping lessons.


5. Don't Get Confused By The Bank!

A common misunderstanding or confusion about debits and credits comes from Bank Statements and bank terminology.

For example, "My salary's been credited to my account", or "Good news! My account is in credit."

Based on the explanations above, shouldn't the word be 'debit'?

Yes and No.

No because the Bank Statements are the bank's own records. The money you pay in to your account is owed to you - you are effectively a Creditor in their books - hence the term.

Yes because if you were keeping your own records, the Bank would be a Debtor to you.


> Accounting Dictionary   > What is Double Entry Bookkeeping