Per the double-entry accounting system, businesses are obliged to record every financial transaction in two opposite accounts: one is credited, and the other is debited. That way, the books will remain in balance and allow fraud detection.
Abiding by the basic accounting equation—Assets = Liabilities + Equity—the double-entry system assures accuracy and transparency of the information, but it still cannot record transactions based on a currency other than money.
Keep reading as we tell you more about this fundamental concept, review its numerous advantages, and look at several cons.
What Is Double-Entry Bookkeeping?
Double-entry bookkeeping (or accounting) is a financial record-keeping system that registers financial operations in two equal yet opposite accounts.
When an account is debited, the influx of money is recorded on the left side of the ledger, whereas credit is recorded on the right as it signifies the outflow of money. Every debit entry must always have a corresponding and equal credit entry.
By doing so, the sum of all debits must be equal to the sum of all credits, which keeps the books in balance at all times and easily detects inaccuracies.
Most modern businesses implement the double-entry system due to its effectiveness in maintaining accurate, transparent, and up-to-date books.
Example of Double-Entry Bookkeeping
Suppose you apply for a business loan in the amount of $10,000.
When you receive the money, you debit your Cash (asset) account for $10,000 but credit the Loan Payable (liability) account for the same amount. In the ledger, the debit entry will be recorded in the left column, whereas the credit one will go in the right column.
Why Use Double Entry Bookkeeping Over Single Entry?
Unlike the system detailed above, the single-entry cash-based one records transactions with single entries only when money is transferred between the interested parties.
As such, single-entry bookkeeping only looks at one side of your transactions, making it very difficult to detect intentional or unintentional errors in your bookkeeping.
Because of that, you can’t even use such a system for preparing your final financial statements, which are essential in tracking your business performance.
Not to mention that current accounting regulations require companies to implement double-entry bookkeeping at all times, especially if they are publicly traded companies and businesses that release their financial data to the public.
Advantages of Double-Entry Bookkeeping
So why is the double-entry method the preferred (and often necessary) accounting system across the U.S. and the rest of the world? Let’s look at its advantages:
- Increased accuracy of financial reports—each transaction is thoroughly checked since it’s recorded in two equal, opposite, and balanced accounts;
- Resistant to accounting errors and omissions—any errors recorded in a double-entry system can be quickly identified as they would affect the balance of the accounts;
- Increased data transparency and consistency—since the double-entry system abides by the accounting equation and follows universal rules and techniques, interested parties can understand, audit, and compare any business;
- Discloses the financial position of a company—allows for a thorough assessment of the financial performance of any business as profits and losses are accounted for;
- Helps managers make informed decisions—devising a plan of action is much easier when you have the relevant financial data at your disposal;
- Prevalent across businesses everywhere—the modern iteration of the double-entry accounting model is used by almost every company in the world;
- Assists in correcting bad financial decisions—businesses can quickly identify their inefficiencies and areas of improvement by looking at the books;
- Improved the business cash flow—firms can understand and manage their cash flow issues and patterns once they see them outlined in a double-entry statement, which will drive better stability and growth.
Disadvantages of Double-Entry Bookkeeping
In addition to all its benefits, the double-entry system does come with a few cons that make it the less desirable system under specific circumstances:
- Complex to understand and implement—the double-entry accounting system requires thorough knowledge of modern accounting principles and techniques;
- Time and money-consuming—bookkeepers and accountants have to track every transaction in several accounts and statements, so more time is spent ensuring every entry is present and accurate, which in turn increases maintenance costs;
- Impractical for small businesses—startups or businesses with limited operations and financial transactions may be unable to handle (financially or professionally) or even require double-entry bookkeeping procedures;
- Does not register inflation—since the double-entry system views money as an inflexible unit of measurement, it does not account for its value changes;
- Does not record non-money transactions—this approach only registers monetary transactions, so intangible assets or other qualitative factors and non-monetary additions may be absent from the books;
- Can be accountant biased—when recording transactions, accountants implement a degree of discretion due to factors like meeting performance targets or maintaining personal relationships, which may result in bias and inaccurate entries.
As you can see, the double-entry system is the best method to account for financial transactions for any business, regardless of its size or activities.
After all, it allows you to create clear and accurate reports that can be inspected easily by any interested stakeholder and used to track the company’s performance over time. Identifying errors is also straightforward, as you can see account imbalances.
On the other hand, using a double-entry system might prove time and money intensive for small businesses that lack the knowledge and finances to implement it. Moreover, it may be accountant biased and cannot track transactions that do not use money.
- Double-entry bookkeeping records each transaction in two accounts.
- The total amount debited must always equal the total amount credited.
- The system makes financial reporting accurate and transparent.
- With double-entry accounting, companies easily estimate their performance.
- Some small businesses avoid it due to its complexity and high costs.