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An Introduction to Double-Entry Bookkeeping

By: Matthew Strawbridge - Updated: 7 Oct 2012 | comments*Discuss
 
Bookkeeping Accounts Finance Small

It’s easy for errors to creep into your financial records. It’s easy to make mistakes when adding up column upon column of figures. Double-entry bookkeeping attempts to minimize these errors by including each figure in two places, as a credit on one account and a debit on another: if the totals are in balance then you can have confidence that the calculations have been done correctly.

Even in this computerised age where columns of figures can be added automatically without error, the double-entry system provides a useful audit trail for your finance: nothing just appears out of thin air!

Financial Categories

The financial books as a whole must cover the value of goods owned by the business (assets), the net worth of (and shareholders’ interest in) the company (equity), money owed (liabilities), money earned (revenue) and costs (expenses).

In double-entry bookkeeping, a separate record (account) is kept for things that the business needs to keep track of, each of which must belong to exactly one of these categories. For example, a business may keep separate books for a development loan and a mortgage, but both would be liabilities.

Each transaction that occurs in the business will result in one or more credit and one or more debit, and the total credits will equal the total debits.

Typical Financial Records and Their Types

Here are some typical small business financial records, categorised by type:

  • cash, current account, savings account, stock and accounts receivable are all assets
  • credit card and accounts payable are liabilities
  • limited companies will have equity; sole traders will not
  • sales will be income; some businesses will have other income accounts
  • travel, utilities and stationery are expenses

Credits and Debits

Credits and debits are easy to understand on a bank statement: a credit is money paid in and increases the running total, whereas a debit is a payment from the account and decreases it. Unfortunately, these terms are not so straightforward in double-entry bookkeeping.

Don’t forget that your bank account is prepared by the bank, and is created from their point of view, not from yours. Whereas your savings account is an asset to you, it is a liability to your bank: it represents money that they owe to you, and you could withdraw it if you wished.

In your business records, the debit side, written on the left, represents the destination point of a transaction; the credit side, on the right, represents where the amount has come from. These are also called T-accounts because they look like a letter T with debits on the left and credits on the right.

A Bluffer’s Guide

It’s not always easy to work out what is a credit and what is a debit. Each transaction usually has one side that is easier to comprehend than the other, so you can use this to work out whether the balancing entry is a credit or a debit.

For example, suppose a business buys a new computer for £1,500 in a “buy now, pay in 6 months” offer. Overall, three sets of records will be affected: equipment (assets), accounts payable (liabilities) and current account (assets).

In the first instance, they get the computer now and agree to pay for it later, so equipment and accounts payable come into play. The easy side of this balancing act is the equipment one: the business is getting a new computer, so their assets are increasing, so it must be a debit of £1,500 to the account. Therefore, to keep things in balance, the accounts payable must be credited by £1,500.

After six months, the company must pay for the computer. Their current account will decrease by £1,500 as will the amount they owe. This is represented by a credit to the current account (which reduces it) and a debit to the accounts payable (which also reduces it) to pay off the finance.

Cash is a useful starting point when thinking about debits and credits: cash received is a debit, cash paid is a credit, and everything else flows from this.

Summing Up

The key points are as follows:

  • debit is on the left, credit is on the right – you can remember this by the phrase “DRive on the left, CRash on the right” (except on a balance sheet, where the order is reversed)
  • money flows from credit to debit

If double-entry bookkeeping does not make sense to you – and it’s certainly not straightforward – then you might like to hire someone to do the bookkeeping for your small business. You can then leave it to them to work out what goes in which column, and spend your time selling your product or service, generating transactions for your bookkeeper to record.

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