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Double entry accounting explained – Transcript
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- Double entry accounting requires that every debit has a credit, with debits placed on the left and credits on the right.
- Technically speaking, the sum of the debit entries needs to equal the sum of the credit entries in double entry accounting.
- Every business transaction involves two or more accounts and must comply with the accounting equation of Assets equal Liabilities plus Equity.
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What is double entry accounting? Double entry accounting or double entry bookkeepingcan be explained in several ways. Perhaps the easiest way to explain doubleentry accounting is to say that every debit needs a credit.
When making accounting journal entries, thedebits go on the left and the credits go on the right. Another way of describing double entry accountingis: both sides of the journal entry need to be recorded. As a lot of journal entries simply have onedebit and one credit, in most cases this is a correct statement.
An example is shown here: you receive an invoicefor $800 worth of outside services. One leg of the entry (the debit) goes to outsideservice expense, the other leg of the entry (the credit) goes to Accounts Payable. Technically speaking, “The sum of the debitentries needs to equal the sum of the credit entries” would be a better way of describingdouble entry accounting.
Here’s a summary example of a more complexjournal entry recording the large acquisition of a company. There are three debits and two credits inthis journal entry. Let’s check whether the sum of the debitentries equals the sum of the credit entries. The sum of the amounts in the debit entriesis $5.7 billion debit + $7.9 billion debit + $16.8 billion debit = $30.4 billion debit.
The sum of the amounts in the credit entriesis $3.4 billion credit + $27 billion credit = $30.4 billion credit. The sum of the debit entries equals the sumof the credit entries!
Here are some more ways of describing doubleentry accounting. There are always two (or more) entries forevery transaction. Every business transaction will involve twoaccounts (or more). Always comply with the accounting equation:Assets = Liabilities + Equity.
Let’s dive into that last description ofdouble entry accounting a little bit deeper. Why do Assets need to equal Liabilities andEquity? Well, at the end of the accounting period,you will be making a balance sheet, an overview of what you own and what you owe, and as thename balance sheet suggests the sum of the amounts on the left has to equal the sum ofthe amounts on the right.
This also means that on the journal entrylevel any increase in one element of the accounting equation has to be offset by an increase inanother element. Assets increase with a debit. Liabilities and equity increase with a credit.
Let’s check that for the acquisition journalentry that we saw before. We first classify the accounts as Assets (A)or Liabilities (L). There are 4 Asset accounts involved in thisjournal entry, and one Liability account. The increase in the Assets accounts is $5.7billion debit + $7.9 billion debit + $16.8 billion debit - $27 billion credit = $3.4 billion.
The increase in the Liability account is also$3.4 billion. So this journal entry complies with the accountingequation Assets = Liabilities + Equity. What about the other example of outside serviceexpenses?
In this example, it is very clear that recordingthe invoice increases Accounts Payable, which is a Liability. But what about the outside service expenses,which is a debit in the income statement? Remember that at year-end, a profit gets addedto Equity, and a loss gets subtracted from Equity.
So this journal entry also complies with theaccounting equation, as Liabilities go up and Equity goes down. So is it ever possible to post a journal entrythat is not balanced? Well, yes and no! But that’s a topic for a different video:suspense accounts.
There are several ways to explain double entryaccounting. I hope that one or more of these explanationsresonates with you! I hope you enjoyed this short explanationof double entry accounting. If you enjoyed this video, then please giveit a like! On this end screen, there are a few suggestionsof related videos you can watch next. Please subscribe to the Finance StorytellerYouTube channel! Thank you.