How to Use Double-Entry Accounting
Double-entry accounting and double-entry bookkeeping both use debits and credits to record and manage financial transactions.
At its core, double-entry accounting is based on the accounting equation, which is:
Assets = Liabilities + Owner’s Equity
By using double-entry accounting, you can be sure all of your transactions are following the rules of the accounting equation. Using this system is the only way to do that.
Unlike single-entry accounting, which requires only that you post a transaction into a ledger, double-entry tracks both sides (debit and credit) of each transaction you enter.
Using this system reduces errors and makes it easier to produce accurate financial statements.
At a glance: How double-entry accounting works
- Step 1: Create a chart of accounts for posting your financial transactions.
- Step 2: Enter all transactions using debits and credits.
- Step 3: Ensure each entry has two components, a debit entry and a credit entry.
- Step 4: Check that financial statements are in balance and reflect the accounting equation.
An overview of double-entry accounting
Benedetto Cotrugli, an Italian merchant, invented the double-entry accounting system in 1458.
The system was later shared by Italian mathematician and Franciscan monk Luca Pacioli, who wrote The Collected Knowledge of Arithmetic, Geometry, Proportion, and Proportionality in 1494, which included a detailed description of the double entry-accounting system.
If you’re a freelancer, sole entrepreneur, or contractor, chances are you’ve been using single-entry accounting, especially if you aren’t using accounting software.
While this may have been sufficient in the beginning, if you plan on growing your business, you should probably move to using accounting software and double-entry accounting.
In order to understand how important double-entry accounting is, you first need to understand single-entry accounting.
The closest example of this basic accounting is the bank account ledger you use to keep track of your spending.
When you log into your bank account online, or receive your bank statement in the mail, you’ll see a list of all of your activity for the month. That activity includes things like the $5.50 you spent at the coffee shop during your breakfast meeting as well as the customer payment you deposited.
While having a record of these transactions is a good first step toward better managing your cash flow, this type of recording doesn’t make clear the impact each transaction has on your business.
This is how you would record your coffee expense in single-entry accounting.
While your ledger gives you an idea of how much money is in your account, it does nothing to help you track your expenses, or know how much money your customers owe you.
In double-entry accounting, you still record the $5.50 in your cash account, but you also record that $5.50 as an expense.
|10/25/19||Meals and Entertainment||5.50|
This shows the same transaction recorded using double-entry accounting.
If you have five or fewer transactions monthly, you can probably use single-entry accounting, but you’ll want to switch to double entry if you:
- Are in a growth phase
- Are currently looking for investors
- Are planning on applying for a bank loan or other financing for your business
How double-entry accounting works
It's possible to manually create multiple ledger accounts, but if you’re making the move to double-entry accounting, you’ll likely want to make the switch to accounting software, too.
The products on the market today are designed with business owners, not accountants, in mind. Even if your knowledge of accounting doesn’t extend beyond Accounting 101, you’ll find most accounting software applications easy to use.
If you're not sure which accounting software application is right for your business, be sure to check out The Ascent's in-depth accounting software reviews.
Once you decide to transition to double-entry accounting, just follow these easy steps.
Step 1: Set up a chart of accounts
While you can certainly create a chart of accounts manually, accounting software applications typically do this for you. Once you have your chart of accounts in place, you can start using double-entry accounting.
Account types you’ll be using in your chart of accounts include:
- Assets: Anything you own
- Liabilities: Anything you owe
- Revenue/income: What your business earns
- Expenses: The cost of doing business
- Owner’s equity: Reflects your current ownership level
Step 2: Use debits and credits for all transactions
A debit is always on the left side of the ledger, while a credit is always on the right side of the ledger.
A debit entry will increase the balance of both asset and expense accounts, while a credit entry will increase the balance of liabilities, revenue, and equity accounts.
|Account||To Increase Balance||To Decrease Balance|
Common account types and how they are increased or decreased.
Step 3: Make sure every financial transaction has two components
Once your chart of accounts is set up and you have a basic understanding of debits and credits, you can start entering your transactions.
For example, you overpaid your electric bill in error last month, and you receive a refund of $200.00 from the electric company.
To enter that transaction properly, you would need to debit (increase) your cash account, and credit (decrease) your utilities expense account.
This is the proper way to enter a refund from the electric company.
If you’d only entered the $200 as a deposit, your bank account balance would be accurate, but your utility expense would be too high.
This can be particularly important when creating an invoice or posting multiple expense reports for travel.
For instance, let’s assume you recently spent $500 on travel. If you were using single-entry accounting, you would simply reduce your bank account balance by $500.
But when using double-entry accounting, you would post your travel expenses in detail, allowing you to see just how much you’ve spent on transportation or other travel expenses, while also providing you with the financial information you need to make better decisions about travel in the future.
Double-entry accounting allows you to better manage business-related expenses.
Step 4: Run your financial statements
It’s impossible to find investors or get a loan without accurate financial statements, and it’s impossible to produce accurate financial statements without using double-entry accounting.
By entering transactions properly, your financial statements will always be in balance.
How to get started with double-entry accounting
If you're ready to use double-entry accounting for your business, you can either start with a spreadsheet or utilize an accounting software.
1. Use a spreadsheet
If your business is really small, you may be able to get by using a spreadsheet application in order to post your financial transactions, but spreadsheets are only useful if you have a very small business and are using single-entry accounting.
2. Use accounting software
While it’s possible to create an adequate business ledger for your business manually, you’ll find yourself spending a lot of time referring to multiple account books to make entries, calculate totals, and later transfer those totals to the correct accounts in order to produce financial statements.
The best way to get started with double-entry accounting is by using accounting software. Many popular accounting software applications such as QuickBooks Online, FreshBooks, and Xero offer a downloadable demo you can try.
All popular accounting software applications today use double-entry accounting, and they make it easy for you to get started, allowing you to get your business up and running in an hour or less.
Using software will also reduce errors and eliminate out-of-balance accounts.
Deciding if double-entry accounting is right for you
- Need to be taken seriously?
- Need to open a line of credit?
- Need to open a business credit card?
- Need to attract investors?
- Need to apply for a loan?
If so, you should utilize double-entry accounting. The system is designed to keep accounts in balance, reduce the possibility of error, and help you produce accurate financial statements.
This then gives you and your investors or bank manager a good picture of the financial health of your business. Even the smallest business can benefit from double-entry accounting.
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