Double-Entry Accounting Equation: Demystifying the Foundation of Bookkeeping

What Is Double Entry Accounting Equation?

The double entry accounting equation is a method of bookkeeping whereby each financial transaction has an equal and opposite effect on at least two different accounts. It makes it possible to satisfy the accounting equation:

Assets = Liabilities + Equity

Assets = Liabilities + Equity

With a double-entry bookkeeping system, credits are offset by debits to the general ledger or T-account.

Key Points To Remember

Double entry accounting equation refers to the accounting concept that assets = liabilities + Equity.

In a double-entry system, transactions are recorded as debit and credit. The double-entry accounting equation foundation of bookkeeping was developed in the era of commerce in Europe to help streamline business transactions and make commercial operations more efficient.

The emergence of the double-entry accounting equation is associated with the birth of capitalism.

Understanding Double Entry Accounting Equation

In accounting, a credit is an item that increases a liability account or decreases an asset account. A debt is the opposite. This is an item that increases an asset account or decreases a liability account. In a double-entry accounting system, transactions are mostly recorded as debits and credits. Since a debit to one account will offset a credit to another, the sum of all the debits must equal the sum of all credits.

The dual foundation of the bookkeeping system standardizes the accounting process and improves the accuracy of the financial statements prepared, allowing for better error detection. All types of business accounts are debited or credited.

Types Of Business Accounts

Bookkeeping and accounting are ways to measure, record, and report a company’s financial information. A business transaction is an economic event recorded for accounting purposes. Generally, it is a business interaction between economic entities, such as a customer and a company or a supplier and a company.

As part of a systematic accounting process, these interactions are often categorized into accounts. There are seven different account types to categorize all business transactions:

  1. Asset
  2. passive
  3. Share
  4. Income
  5. Expense
  6. Income
  7. Losses

Bookkeeping and accounting keep track of changes made to each account as the business continues to operate.

Debit And Credit Cards

Debits and credits are required for the double-entry accounting equation system. In accounting, a debit refers to an entry on the left side of the ledger, and a credit refers to an entry on the right side of the ledger. To balance, the total debt and credit balance of a transaction must be equal. Debt does not always correspond to an increase, and credit does not always correspond to a decrease.

A debit can increase one account while decreasing another. For example, a debit increases the asset account but decreases the liability and equity accounts, which supports the general accounting equation Assets = Liabilities + Equity. On the income statement, debits increase the balances of the expense and loss accounts, while credits decrease their balances. Debits decrease the income account balance, while credits increase the account balance.

Dual Bookkeeping System

The foundation of bookkeeping was developed in the era of commerce in Europe to help streamline business transactions and make commercial operations more efficient. It also helps traders and bankers understand their costs and profits. Some thinkers have argued that double-entry bookkeeping was an important computing technology that contributed to the birth of capitalism.

The accounting equation basically forms the basis of double-entry bookkeeping and is a brief presentation of a concept that extends to complex, extensive, and multi-item balance sheet presentations. The balance sheet is based on a double-entry accounting system where the total assets of a company equals the sum of its liabilities and Equity.

Essentially, the presentation equates all uses of capital (assets) with all sources of capital (where debt leads to liabilities and Equity leads to Equity). In order for the business to maintain the correct accounts, each business transaction should be reflected in at least two accounts.

For example,

If a business borrows money from a financial institution such as a bank, the amount borrowed will increase the assets of the business, and the debt obligation of the loan will also increase by the same amount. If a company purchases raw materials by paying cash, inventory (an asset) will increase while cash capital (another asset) will decrease.

Because there are two or more accounts affected by each transaction made by a business, the accounting system is known as double-entry bookkeeping.

This practice ensures that the accounting equation is always balanced. This means that the value on the left side of the equation will always match the value on the right side.

Example Of Double Entry Accounting Equation

A bakery purchases refrigerated delivery trucks on deferred payment; The total purchase amount on credit is 250,000 USD. The new truck sets will be used commercially and will not be sold for at least ten years – their estimated useful life.

To account for purchases by credit, entries must be made in the respective ledger. Since the company has accumulated more assets, the asset account will debit the purchase cost ($250,000). To account for purchases on credit, a credit of $250,000 will be placed on the payable slip. A debit entry increases the asset balance, and a credit entry increases the liability balance by the same amount.

Dual entries can also occur in the same class. If the bakery purchase was made with cash, a credit would be made in cash and a debit to the property, which would still result in a balance.

What Is The Difference Between Single Bookkeeping And Double Bookkeeping?

In one-time foundation of bookkeeping, when a business makes a transaction, the business records that transaction in an account. For example, if a business sells goods, the costs associated with those goods are recognized when the goods are purchased, and revenue is recognized when the goods are sold.

With the double-entry bookkeeping method, when goods are purchased, inventory increases and assets decrease. When the asset is sold, it records a decrease in inventory and an increase in cash (assets). Double-entry bookkeeping provides an overall view of a company’s transactions and a clearer financial picture. 

What Are The Disadvantages Of The Double Bookkeeping System?

The main disadvantage of the double-entry accounting system is that it is more complex. It requires two entries to be recorded when a transaction takes place. It also requires mathematically that the debits and credits are always equal. In the long run, this is more beneficial to the business than a one-time bookkeeping.

What Is An Example Of A Double Entry Accounting Equation?

An example of double-entry bookkeeping is if a business takes out a $10,000 loan, and the loan is credited to both the debit and credit accounts. The cash (asset) account will be debited with $10,000, and the debit (liability) account will be credited with $10,000. In a double-entry system, the debit account and the credit account will be equal.

The End

The double accounting method has many advantages over the one-time accounting method. On top of that, it gives the organization a complete understanding of its financial records by noting. How a transaction affects both credit and debit accounts. It also makes it easier for you to spot errors because if the debit and credit amounts don’t match, something goes wrong. Finally, it facilitates the preparation of financial statements.

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