A Business Owner’s Guide to Double Entry Accounting

Accounting journal entries on blue background

As a business owner, you’ve navigated your way through tough challenges and taught yourself some new skills as you figure out each area of your business. We’ll admit that accounting can be a bit of a black hole for business owners—you don’t want to be an accountant, but you do want to have enough accounting know-how to run your business successfully. But suddenly, two hours have passed and you’re no closer to understanding when to debit and when to credit. 

Like being a kid at school, you might wonder when you’re ever going to use this stuff. 

Double-entry accounting is a lot like learning multiplication. Understanding how to do it will equip you for all sorts of business challenges, specifically like how to read your financial statements with confidence and make thoughtful financial decisions. But just like there’s little benefit to knowing what 456 x 1,920 equals off the top of your head, there’s little benefit to knowing every last rule to double-entry bookkeeping.  

With that in mind, we promise not to overcomplicate this. 

What is Bookkeeping?

Before diving into the double-entry system, let’s back up a step and define bookkeeping as a whole. 

Bookkeeping [Book k-kee ping] noun: The act of recording and organizing information relating to the financial transactions of a business.

In essence, when your business makes or spends money, you need to track it. There are some very specific rules for how to do that tracking, which we’ll begin to explore here. (If you’re interested in diving deeper into those rules now, check out this post on the Generally Accepted Accounting Principles.) 

Get to Know the Basics of Bookkeeping

The hardest part is knowing where to start. We’ll show you the way.

What is Double-Entry Bookkeeping? 

There are two styles of bookkeeping: single-entry and double-entry. We’ll go into the differences between them, but for now, know this: the overwhelming majority of businesses will use the double-entry system

If you’re a new business or a very small business, you might use single-entry bookkeeping to manage your transaction data. However, if your business finances have complexities like accounts receivable or accounts payable, you’ll likely default to double-entry bookkeeping. And if you’re using accounting software of any sort, that software will automatically run on the double-entry system. 

A Brief Reminder: Accrual vs. Cash

When many people think of techniques for handling their accounting, they often think of cash basis accounting and accrual basis accounting. 

Here’s a quick rundown of the difference: 

Cash accounting recognizes revenue and expenses in your books when money changes hands.

 

Accrual accounting recognizes revenue and expenses when they’re incurred (or fulfilled), regardless of whether money changed hands yet.

The difference in these two accounting methods, as you can see, has to do with when money is recognized in your books. If you send invoices or pay bills at later dates, you’ll likely lean toward the accrual method.

But if you’re following the rules of either cash or accrual accounting, you’ll still use double-entry bookkeeping. Single-entry bookkeeping is really only reserved for businesses that are so simple, they can manage everything in a straightforward Excel spreadsheet.

Single-Entry vs. Double-Entry: What’s The Difference? 

The overall complexity of your business will help dictate whether you manage your books using the single-entry or double-entry bookkeeping method. But let’s get down to brass tacks. 

What’s really different between these two methods? What do you do when you open your accounting file?  

The biggest difference is that single-entry accounting could be done in a simple spreadsheet. It’s similar to balancing a checkbook. For your columns, you’ll have the date, as well as a column for income and one for expenses. When you earn money, you’ll mark the date and add the amount to the income column. Vice versa when you spend it. 

Single-Entry Excel Bookkeeping Example

TransactionDateIncome Expense
Online Purchase 05/01/2020$750
Office Depot05/05/2020
$150

There’s no general ledger or complex chart of accounts, which can certainly seem appealing. The down side, however, is that you learn very little from this system. If you want to know how much money you’re expected to bring in or what bills you have coming up, you’re out of luck. Likewise, if you’ve been paying down a loan, you have no way of seeing how you still owe by looking at your books. 

The double-entry system gives you a much more detailed view of your finances, and it does this through debits and credits. We’ll dive into them a little more below. For now, know that every transaction should be recorded at least twice—once as a debit and once as a credit. Every debit amount should have an equal credit amount. 

When you categorize a transaction in your accounting system, this should happen more or less automatically, but we’ll give you some back story of how it was once done by hand. 

A Brief Aside: The History of Ledgers

 

When finance professionals began writing down transactions, they’d have several different books, known as ledgers. They’d have a ledger for every type of transaction, like a one for cash, accounts receivable, expenses, inventory, etc. Throughout the month, they would write down the debits and credits affecting certain accounts in their individual ledgers. At the end of the month, they’d tally up all the debits and credits in each ledger and add the balance to the general ledger.

 

The general ledger is the master ledger. It’s basically a summary of all the accounts in your chart of accounts (or all the types of ledgers you have). If you wanted the biggest of big-picture views of your business, you would turn to your general ledger.

 

Even though the world of accounting has evolved beyond the use of physical ledgers and writing down debits and credits by hand, finance professionals continue to use the same jargon to apply to the different parts of the bookkeeping process (which is why we included this brief aside).

So when you log into your accounting system, you might classify a transaction as an ”Office Supply” payment. But behind the scenes, your software should know to debit your Cash account and credit your Office Supplies expense account. 

Doing so allows you to see not only the bottom line of how much money you made or lost, but it also shows you the other areas of your business that were impacted as a direct result of that transaction. Every financial transaction impacts something else. If you spend money, you lose cash but (presumably) gain something in return. If you earn it, you’ve got cash in your pocket but you likely lost some inventory.

It’s easy to get hung up on the rules of double-entry accounting, but you can get past that by recognizing that it has a push-and-pull nature. 

The Accounting Equation 

At the heart of debits and credits is the accounting equation. It says: 

Assets = Liabilities + Equity 

You might recognize assets, liabilities, and equity as the three primary components of your balance sheet, and balance is the name of the game. For a very short primer on these three terms, here’s how we think about them. 

  • Assets: What your company possesses (cash, inventory, a delivery truck you still owe money on, etc.) 
  • Liabilities: What your company owes to someone else (bills, upcoming payroll, the remaining payments on that delivery truck, etc.)
  • Equity: What your company owns outright (past earnings, stock, a portion of that delivery truck, etc.) 

The goal of the accounting equation is to make sure that you know who owns everything that your company possesses at any given moment. For that reason, it’s important that the two sides of the equation stay balanced. 

What I Possess = What Others Own + What I Own

When a transaction takes place, it may impact only one side of the equation, or it may impact both. 

Let’s take the office supplies you purchased. You spent cash (which is an asset because it’s something you possess) to purchase an equal value of supplies (also an asset). So you only impacted the left side of the accounting equation and kept the overall equation in balance. 

Now, consider if you’d purchased a delivery van with the help of a loan. You possess a whole vehicle (an asset). You probably paid a down payment in cash (an asset), but you also owe money for the rest of the vehicle (a liability). In order to keep the equation balanced in this case, you must touch at least three accounts using debits and credits and both the left and right sides of the equation. 

Income Statement Accounts

While it’s important to ensure that the accounting equation stays balanced as you make debits and credits, there are some accounts that don’t fit squarely into the equation that you’ll need to remember. (In case you were hoping for a little more complexity.) 

These accounts are Income and Expense accounts

You may notice that these are the same terms you’ll see on an income statement, or P&L statement. Keep in mind that the goal of making all these journal entries is to produce accurate financial statements at the end of the accounting period. In order to create the income statement, you need to track all the transactions relating to the cost of doing business. 

When you think of “Income,” think about the value of the work that you do. You may have a couple accounts in your chart of accounts that fall under “Income,” but the primary one will probably be your Revenue account. 

When you think of “Expense,” think of the cost of doing that work. You may have several expense accounts, like: 

  • Cost of Goods Sold 
  • Wages Expense 
  • Rent Expense
  • Utilities Expense
  • Supplies Expense

The more entries you make, the more you’ll get the feel for which accounts are affected when certain things happen. It’s very common that you’ll make entries in both balance sheet accounts (things pertaining to assets, liabilities, and equity) and income statement accounts (income and expenses) at the same time. 

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The Basics of Debits and Credits 

At this point, we’ve covered the philosophy of double-entry accounting and the accounting equation. But even with a strong philosophical understanding, it can be difficult to know when to debit and when to credit certain accounts. 

The simplest way to understand it is to know that some accounts usually carry a credit balance and others carry a debit balance. When you credit those accounts that typically have a credit balance, you’ll increase the amount. Likewise, with debit accounts. When you debit those, they’ll increase. 

The accounts that usually carry a debit balance are: 

  • Dividends (or Draws)
  • Expenses
  • Assets
  • Losses

The accounts that usually carry a credit balance are: 

  • Gains
  • Income
  • Revenues
  • Liabilities
  • Stockholders’ (Owner’s) Equity

If you’re looking for a fun way to remember this, the first letters of each spell out DEALs and GIRLS, respectively. 

Note: Unless you’re buying or selling real estate, you probably won’t need to deal with Gains and Losses accounts. For the sake of simplicity, we’re also not going to talk about Dividend or Equity accounts here. 

Note: Unless you’re buying or selling real estate, you probably won’t need to deal with Gains and Losses accounts. For the sake of simplicity, we’re also not going to talk about Dividend or Equity accounts here.

Outside of simply memorizing the above lists, making debits and credits takes practice. Over time, you’ll see that some accounts have natural relationships between them. It’s often easier to think of accounts in pairs than to pull from the list above. Here are some of the most common examples. 

Debit & Credit Examples

When you sell a product, you’ll…

  • Debit Cash Account (Asset)
  • Credit Inventory (Asset) 
  • Credit Revenue Account (Income)

If you sell something using an invoice, you’ll…

  • Send Invoice: Debit Accounts Receivable Account (Liability), Credit Revenue Account (Income)
  • Receive Payment on Invoice: Credit Accounts Receivable Account (Liability),  Debit Cash Account (Asset) 

When you buy supplies, you’ll: 

  • Receive a Bill: Credit Accounts Payable Account (Liability), Debit an Asset Account (most likely a sub-account relating to what you received from this transaction) 
  • Pay a Bill: Debit Accounts Payable Account (Liability), Credit Cash Account (Asset) 

When you pay regular expenses, like rent or payroll, you’ll…

  • Pay Rent: Debit Rent Expense Account (Expense), Credit Cash Account (Asset), Debit Accounts Payable (Liability)
  • Run Payroll: Debit Payroll Expense Account (Expense), Credit Cash Account (Asset), Debit Wages Payable (Liability) 

Adjusting Journal Entries

At the end of the month, one of the steps in the process of closing the books is creating a trial balance. A trial balance is an opportunity to check your work and to ensure that your total debits do, in fact, equal your total credits. If not, you’ll make some journal entries to adjust the amounts so they do properly line up. 

So don’t worry if you feel a little unsure. You will have an opportunity to double check your work.

On top of being used to fix mistakes in your day-to-day bookkeeping, journal entries can add more clarity to some transactions. 

For example, when you run payroll, you might make a single journal entry to show that you’ve spent money in your Cash account on a Payroll expense. But after that, you might want to break that payroll expense down further by making journal entries to wages, 401k, or tax accounts.

Another common example is using journal entries to show depreciation every month. 

When you make journal entries, money doesn’t always need to change hands. Sometimes, you’re just taking what’s there and rearranging it in order to make your financial statements more precise or accurate. 

Journal entries when money isn’t changing hands can be a little tricky because the relationship between accounts is subtler, so these are often handled by an accountant

Does online accounting software make double-entry accounting obsolete? 

Now, to the question we started with. Will I ever need to know all of this? Don’t computers make this whole process moot? 

Generally speaking, yes. Accounting software can speed up the process immensely—to a point. Software can recognize patterns very well, meaning it can classify most transactions pretty easily, taking much of the everyday work of making debit and credit entries off your plate. 

But software isn’t infallible. Nor can it decode things like checks, that don’t provide much information in your bank feed, very easily. So it’s important that someone knowledgeable in accounting can do the work of double checking and make adjusting journal entries at the end of the month. It also means you’ll still need to help the software out from time to time to recognize unfamiliar transactions. 

The rules and guidelines for accounting are centuries old, and they’re complex. We’re setting out to change that so that business owners don’t need the help of accountants to decode their own finances. Learn how we can take the burden of bookkeeping off your plate and give you numbers you can use to run your business. 

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