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....