Double-Entry Bookkeeping Explained in Less Than 500 Words

It’s a centuries old system that still works (and is the gold standard) for keeping accurate financial records. But because of QuickBooks and other popular bookkeeping software programs that hide the double-entry recordkeeping behind the scenes, many small business owners and even bookkeepers themselves are left scratching their heads asking, “What is double-entry bookkeeping?” So let’s quickly untangling the basics of how this classic bookkeeping system actually gets the job done. In a nutshell, the whole double-entry bookkeeping system is based upon the Accounting Equation: Assets = Liabilities Equity. This is what makes a Balance Sheet balance, and is a way to assure accuracy. If assets do not equal liabilities and equity, it means there is an error somewhere in the financial records. Therefore, when a journal entry is created to capture a transaction in the financial records, it is entered twice (hence, double-entry). It’s entered first as a debit to one account and again as a credit to another account. What are debits and credits? Every General Ledger account has two sides (all accounts used to track financial transactions in the Chart of Accounts = the General Ledger).

The left side is the debit and the right side is the credit. This never changes. But how the debit or credit entries affect the balance carried in an account–either increasing it or decreasing it–is not always the same. That is because the type of account determines the side on which the balance is usually carried. There are 5 account types: asset, liability, income, expense, and equity. The cardinal rule of journal entries is, for every debit to an account, there must be a credit of equal value to another account. Sometimes these debits and credits for a single transaction are split up among more than two account, but the total debits and total credits must Always balance. If they don’t, it means the transaction is not entered correctly. So, how do you determine which account is to be debited and which to be credited? There are two steps: 1. Determine which two (or more) accounts are affected by the transaction 2. Create a journal entry to debit and credit these accounts accordingly To accomplish step 2, you need to know whether a debit or a credit will increase or decrease the involved accounts’ balances.

To know that, you need to know which side of each of the five main types of general ledger accounts carries the normal account balance, whether the debit side or the credit side. The short answer is, Asset and Expense accounts carry debit balances, and Liability, Equity and Income accounts carry credit balances. Of course, if you had a cheat sheet to keep all of this straight, you wouldn’t have to try to remember it all in your head. You’d have the answers at a glance.

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