Double entry system - Bookkeeping

Most countries in the world follow the double entry system to do the bookkeeping. The same principle is used by all accounting software.

A double entry system is an accounting method that records financial transactions by entering them in two or more accounts. This system is based on the principle that every transaction has two aspects: a debit and a credit.

In a double entry system, every transaction is recorded in two accounts: one account is debited, and another account is credited. The debit entry represents the amount of the transaction that is going out, while the credit entry represents the amount of the transaction that is coming in.

For example, if a company purchases inventory for $1,000, the double entry would be:

         Debit the Inventory account by $1,000, representing an increase in assets

         Credit the Cash or Accounts Payable account by $1,000, representing a decrease in assets or increase in liabilities

The use of a double entry system ensures that the accounting equation, which states that assets must always equal liabilities plus equity, is always balanced. This provides a reliable way to track financial transactions and ensure accurate financial reporting.

As we understand the double entry system records or categorize a transaction into a general ledger. The process f recording is based on the three golden rules and these rules are applied based on the nature of the general ledger. Before we jump into describing the three golden rules let’s look into what are the nature of general ledgers.

The nature of general ledgers:

       1- Personal ledger

       2 - Real ledger

       3 - Nominal ledger

Personal ledger – a personal ledger is a ledger of a personal name which could be your supplier or a customer. A personal name includes the name of a legal entity.

Real ledger – A real ledger refers to a ledger that you can see physically, like materials, property, etc.

Nominal ledger – the nominal ledger is ledger refers to a ledger that you can not see physically for example, traveling expenses, interest income, etc.

Now let’s discuss about the three golden rules of the double entry system.

Debit the receiver, credit the giver: This rule applies to transactions where an asset is received or an expense is incurred. For example, when a company purchases inventory for cash, the Inventory account is debited (because an asset is received) and the Cash account is credited (because the giver is the company). This rule applies to personal ledgers.

Debit what comes in, credit what goes out: This rule applies to transactions where revenue is earned or a liability is incurred. For example, when a company sells goods on credit, the Accounts Receivable account is debited (because revenue is earned) and the Sales account is credited (because what goes out is the goods sold). This rule applies to a real ledger.

Debit expenses and losses, credit income and gains: This rule applies to transactions where an expense is incurred or income is earned. For example, when a company pays rent expense, the Rent Expense account is debited (because an expense is incurred) and the Cash account is credited (because what goes out is the cash paid). Conversely, when a company earns interest income, the Interest Income account is credited (because income is earned) and the Cash account is debited (because what comes in is the cash received). This rule applies to nominal ledgers.

These rules ensure that every transaction is recorded with a debit and a credit entry, which keeps the accounting equation in balance and ensures accurate financial reporting.

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