Double Entry Bookkeeping - What is it and why should you know?

Bookkeeping, as the name implies, is the recording of financial transactions of a business. The double-entry concept is a set of rules that has been universally adopted and around since the 12th century. It was famously codified in the late 15th century by Luca Pacioli, an Italian monk.

Ok, enough of the history lesson. As the name implies, every transaction has two sides, (known as a debit and a credit). For example a cheque or other payment affects both the bank account and a cost category. A sale creates income as well as a debtor (or money in the bank). It is possible for a transaction to involve more than two entries but the total debits must equal the total credits. Things like the GST and inventory management will complicate this by creating additional entries – but the basic rule still applies.

A transaction is entered (“posted”) as a journal into the accounting system (whether this is software, a book or ledger or a cloud application – see future newsletter about the latter!). A journal shows the account name (or code) for each debit and credit created by that transaction. Part of this may be automated as a ‘specialised journal’ so you don’t see the transaction in this way, for example

• A payment will automatically credit the bank account so only the debit needs to be manually coded)
• A sale or invoice will automatically debit Trade Debtors (Accounts Receivable) with the credit then coded to the appropriate income account

Often when a journal is posted from scratch (select debit and credit) it is called a general journal.

The beauty of this system is the inbuilt data integrity check, or internal control.

• Each transaction updates the balance of an account (whether that is the bank, debtors, income or expense) that can be independently reconciled and verified (such as to a bank statement, list of debtors, invoice register etc).
• A list of the balances in your accounting system at any point in time is called a Trial Balance. The total debits must equal the total credits (or the overall total of balances must be zero if credits are shown as negatives which is sometimes the case).

This is not a guarantee of error-free accounting but can reduce the risk – the wrong ledger accounts may still be used.

Now, I can hear many people asking why should they know this? Well it is very difficult (if not impossible) to make a system work for you if you don’t fully understand how it functions – not necessarily in detail, but at least conceptually. That is, unless you’re looking after the bookkeeping yourself, which many of us are – in this case an understanding of the subject will help you to more efficiently use your accounting software which uses the same principles....

What or how much, accounting does your business need?

The way your bookkeeping system and chart of accounts are set up will largely be determined by what type of accounting you want. You don’t want to put time, effort and money into detailed recording of transactions if you are not going to use all that information. Do you need or want to have the ability of producing top quality reports about your business now or in the future? The size and structure of the business may predetermine some or all of this but for small and medium enterprises [SME’s] there are usually more options available.

Tax Accounting

Many small and microbusinesses only need, or want, their bookkeeping to be able to produce reports and summaries which can be given to their tax advisor to do the annual tax computation. Minimal detail is required but there are specific requirements which you will need to meet – such as on entertainment, assets and personal v business use as appropriate. If the business is required to register for GST more detail will be required but again, if tax is the sole motivation then a relatively simple (and probably cheap) system can be maintained.

It is best to seek tax advice as early as possible from your accountant. Also you may be able to reduce their bill if your records are well kept and in order.

Financial Accounting

This is generally associated with compliance – whether with the Corporations Act or other legislation, or indeed with other requirements such as a debt covenant or external investor or stakeholder.

There are strict rules and guidelines which reports must follow, such as IFRS [International Financial Reporting Standards], and that will determine in turn how the accounts need to be set up. In most cases financial accounts or statements will also be subject to external audit.

Management Accounting

This area of accounting is the least defined but probably the most useful to SME owners or managers. It is generally more detailed and tailored to each business – and also to must be able to produce and be consistent with tax or financial accounting reports as necessary.

Management reporting shows the business the way the owner wants to look at it, generally focussing on KPI’s [Key Performance Indices] which are the drivers of the business. The analysis should be in practical terms that can be used to grow or make the business more efficient – such as revenue or cost per room for a hotel, or per litre for a fuel business, or percentages for a service business etc.

The detail, accuracy, consistency and timeliness of the bookkeeping will determine how informative, reliable and timely the reports are – and ultimately how useful they are.


So whether you manage your business based solely on the bank statement or on detailed reports and analysis, the accounting will determine the resources needed and the desired outputs will determine the type of accounting.