UNDERSTANDING THE DOUBLE-ENTRY ACCOUNTING

This post is a continuation of my last post titled “rules of debit and credit”. We shall be discussing Double-Entry Accounting. I recommend that you should read the rules of debit and credit if you have not already.     

Here is a quick summary of the last post:

Debits and credits are two terms used in accountancy to record transactions between accounts. They refer to the movement of value between accounts and are recorded on the balance sheet and profit & loss statement.

By debiting an asset or expense account you increase its value

By debiting a liability, equity, or revenue account you decrease its value.

By crediting an asset or expense account, you reduce its value.

By crediting a liability, equity, or revenue account, you increase its value.

Now, let us look at double-entry accounting.

What is double-entry accounting?

When a company records a transaction, at least one account will always be debited, whilst at least one other will always be credited, hence the name “double-entry”. There will always be at least two entries to any transaction.

These entries show the movement of value around the business. So, essentially, every action reacts. Much like in physics where energy can never be created or destroyed, value can only ever be transferred.

Double-entry accounting is used to ensure that there are no errors in a company’s accounts and that everything is accounted for. If one side of the double-entry were missing, the company’s accounts would be incomplete – the company would not have fully explained the transaction.

The accounts every company has are revenue and expense accounts (which can be found on the profit and loss report) and asset, liabilities, and equity accounts (which can be found on the balance sheet).

When performing double-entry accounting, the value gained or lost in one account must be equal to that of another account.

This may sound confusing, so let us break it down. You may remember the table below from part 1. This table displays how each account is affected by either being debited or credited.

So, what does this all have to do with double-entry bookkeeping?

When you perform a transaction, the total amount must be equal with both a credit and a debit. If the total amount is not equal, then there is an error. They must always be equal or balanced.

This is similar to the balance sheet, where one half must always be equal to the other. The double-entry method keeps account entries accurate, enabling the financial health of a company to be monitored in a standardized way.

How is double-entry accounting used in business?

In this section, we are going to go through a couple of examples of how the double-entry method is used in real-life scenarios.

Example 1

Event 1: Your company purchases a computer for NGN1,000,000. However, you sign an agreement to pay for the computer next month. So, what happens to the accounts?

Impact in account

Your fixed asset account (an asset account) is debited NGN1,000,000.

Event 2: A month passes and you pay for the computer with cash.

Impact in account

Your cash account (an asset account) is credited NGN1,000,000.

Your accounts payable (a liability account) are debited NGN1,000,000.

As you can see, with both transactions, one account will always be debited, whilst another will always be credited.

Example 2

Event 1: Your company pays NGN2,000,000 of rent for a unit space. You pay the rent on time, on the day that it is due. So, what happens to the accounts?

Impact in account

Your operating costs account (an expense account) is debited NGN2,000,000.

Your cash account (an asset account) is credited NGN2,000,000.

Event 2: Next month when the rent is due, you cannot afford it. You agree with the landlord that you will pay it the following month in addition to that month’s rent. So, for this month:

Impact in account

Your accounts payable (a liability account) are credited by NGN2,000,000.

Your operating costs (an expense account) are debited by NGN2,000,000.

Event 3: A month passes, and you pay your dues.

Impact in account

Your accounts payable (a liability account) are debited by NGN2,000,000.

Your operating costs account (an expense account) is debited NGN2,000,000.

Your cash account (an asset account) is credited NGN4,000,000.

In conclusion, we have covered the rule of debits and credits in the last post, and we have covered double-entry accounting. I will be adding a third series where I am going to be covering T-accounts. So, be my guest next week.

Thank you and remember to like, share and comment.

Written by Hay-R-Hay.