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.
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.
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.
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.
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:
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:
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.
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