Double-entry bookkeeping is a system of accounting for financial transactions that has been used for hundreds of years. It underpins every cloud-based bookkeeping system, banking system and reporting system used by businesses globally.
It allows a business to track all its transactions and helps it to understand how it is performing in terms of profitability, cash balances and business growth. It also supports all the ongoing reporting and submission requirements businesses have – VAT returns, annual accounts, tax returns, etc all rely on double-entry bookkeeping.
What are the principles of double-entry bookkeeping?
The principles of double-entry bookkeeping are very simple – every transaction will have two equal and opposite elements. So for example, if you sell goods your cash balance increases and your stock levels will go down. This is why accountants talk about things balancing and make references to a ‘balance sheet’ in accounts.
The entries resulting from double-entry bookkeeping are often referred to as debits and credits. These represent the two sides of every accounting transaction.
A business’ accounting records, whether simple or complicated, will be an accumulation of these double entries. These entries can then be summarised in what is called a general ledger, which represents the sum of all entries, analysed by type.
If you record these journal entries in a general ledger, debit entries are recorded on the left, and credit entries on the right. These are summarised in a trial balance, which shows the account balances broken down by type being the sum of all related debits and credits. When done correctly, your trial balance will show the overall balance of credits is the same as the overall debits balance.
Your general ledger will include a page for all your accounts in what is called a chart of accounts, which are arranged by account categories. A general ledger is usually divided into at least nine main categories:
- Assets
- Liabilities
- Capital Introduced
- Owners’ equity/shareholding
- Income
- Expenses
- Drawings
- Gains
- Losses
The main categories of the general ledger can often be reduced into sub-ledgers to include additional details such as cash, accounts receivable, accounts payable, etc.
Here is a simplified look at how debits and credits work under the double-entry bookkeeping system.
- Debits
- Increase an asset account, or decrease a liability account or equity account (such as owner’s equity)
- Increase an expense account
- Decrease revenue
- Always recorded on the left side of a ledger
- Credits
- Increase a liability or equity account, or decrease an asset account
- Decrease an expense account
- Increase revenue
- Always recorded on the right side
What is double-entry bookkeeping used for?
Double-entry bookkeeping (which is sometimes referred to as double-entry accounting) allows a business to record all its financial transactions in a structured way. It can then provide the owners or their accountants with the information they need to deal with all the tax and financial submission requirements the business will have such as VAT returns, annual accounts, tax returns and cash flow statements.
It also enables business owners to track their finances on a regular basis, helping them to understand how the business is performing and supporting key financial decisions.
Using double-entry bookkeeping to record transactions provides you and your accountant with a detailed, comprehensive view of your financial affairs.
Who should use double-entry bookkeeping?
Very simply, all businesses will need to use double-entry bookkeeping. It is the only way to ensure that financial information is complete and correct and will support all the ongoing reporting functions that a business may have.
Some business owners will deal with the entirety of their double-entry bookkeeping, however in most cases, bookkeepers or accountants are involved to help set up and run suitable systems to deal with bookkeeping needs.
Examples of double-entry bookkeeping
Some examples of how double-entry bookkeeping works are set out below:
Example 1: Buying with cash
You have started a new takeaway business and want to buy a new phone for when you are out on deliveries.
Under double-entry accounting, you would make two entries: you trade one asset (cash) for another asset (mobile phone). You must therefore adjust both the cash and mobile phone accounts in your double-entry ledger:
Account, Debit, Credit
Cash – £1,000
Mobile phone – £1,000
With double-entry bookkeeping, each debit must always have an equal corresponding credit to keep this equation in balance: Assets = Liabilities + Equity
This is known as the accounting equation, and it is at the heart of double-entry accounting. If at any point this equation is out of balance, it will mean the bookkeeping process has gone wrong at some time.
In this example, only the assets side of the equation is affected: your assets (cash) decrease by £1,000 and your mobile phone assets rise by £1,000, and the equation remains balanced.
Example 2 – Buying on credit
You have bought £5,000 of food for your catering business on credit.
In this case, the asset that has increased in value is your stock. Because you bought this stock on credit, your accounts payable (creditors) account also increases by £5,000.
Account, Debit, Credit
Inventory – £5,000
Accounts payable – £5,000
Applying the Assets = Liabilities + Equity means in this instance both assets (+£5,000 in stock) and liabilities (+£5,000) are affected. Both sides of the equation rise by £5,000, and the equation remains balanced.
Bookkeeping Software
The traditional approach to bookkeeping for businesses is changing. Although manual records, spreadsheets and even desktop accounts software have done the job for many years, the evolving needs of small and medium-sized enterprises (SMEs) require a more agile bookkeeping solution.
Business owners are increasingly working remotely, at least in some way, shape or form. It’s more important than ever to have flexible access to your finances.
These needs have driven the development of cloud-based bookkeeping systems, which now dominate the small and medium-size business market.
These systems automate aspects of double-entry bookkeeping and are key tools for business owners, accountants and bookkeepers.
Looking ahead, there is increasing pressure on small businesses to digitise their accounting and tax reporting. Digital compliance is becoming a necessity given the emergence of Making Tax Digital (MTD). This move to digitalisation will encourage more and more businesses and individuals to look at cloud-based bookkeeping solutions.
We make bookkeeping simple
It may feel like you can save money by doing everything in your business yourself. However, using a local bookkeeper can save you time and money in the long run. These savings come from a reduced level of risk of human error, years of experience working with many other clients, no missed payments to HMRC or missed tax deadlines. Add to this the benefits of tax planning and business reporting and you will see that choosing a local bookkeeper is one of the best decisions you can make.