ACCOUNTING TERM: Double-Entry Method
Double-entry is a method of accounting that uses two
sides of a ledger page to keep track of transactions. The accounting equation, Assets = Liabilities
+ Equity is the foundation for this system.
All entries on the left (debit) side must equal all entries on the right
(credit) side of the ledger. When both
sides are equal, the books are said to be “in balance”.
QUESTION: Why does a Balance Sheet Balance?
This is a good question
because the answer is fundamental to the double-entry accounting method. The answer is very simple but often
overlooked due to its simplicity. Confusion reigns until this one is figured out. Here it is:
You just bought a house priced at $200,000. You made a $50,000 down payment and mortgaged
the difference of $150,000. The
accounting formula says:
ASSETS = LIABILITIES + EQUITY
Or
$200,000 = $150,000 + $50,000
It's amazing how this simple concept slips by so many people when seen in the
context of an accounting Balance Sheet.
The key to remember is that whatever the difference between the Assets
of your business and the amount of Liabilities owed by the business is your
Equity.
The house example is easy to
understand because the Liability is directly related to the Asset. In a business, you must see at the aggregate
of all the Assets and all the Liabilities to determine your Equity. This is the concept I want you to understand.
Double-entry says the Assets are on the debit side of the ledger and Liabilities
and Equity have to make up the same amount on the credit side of the ledger. Let’s see how it looks in journal entry form:
DESCRIPTION DEBIT CREDIT
Cash 200,000 -
Notes
Payable - 150,000
Capital
Contribution - 50,000
These
three entries represent an increase to each account
Why does a Balance Sheet
“balance”? Because, a Balance Sheet, by
its very nature, has to.
TIP: Cash As A Reference
Once one side of the journal
entry is known, you automatically know what the other side has to be. In other
words, if you know what the debit is, then you know the other side will be a
credit entry, and vice versa. The following is a useful technique that is great
for beginners or people who have to write journal entries infrequently. Essentially, it works for those who haven’t
memorized the
Accounting Model:
The general ledger account,
Cash, is involved in many transactions, therefore, it can be used as a
reference. Memorize that a debit to Cash
is an increase and a credit to Cash is a decrease. When you figure out whether Cash should be increased
or decreased, you will know on what side of the ledger to record the transaction.
Increase in Cash
DESCRIPTION DEBIT CREDIT
Cash 50.00 -
? - ?
Decrease in Cash
DESCRIPTION DEBIT CREDIT
? ? -
Cash - 50.00
You will also know what side
of the ledger the rest of your transaction will be on.This way you quickly
resolve half of the transaction. Here is
an example:
You are recording entries from
your bank reconciliation. One of the
entries is a NSF (non-sufficient funds) check amount from one of your customers
for $75.00. Think about what happened: A
customer paid you and you recorded it as a deposit when it came in. That increased your bank account. Now the bank is saying the check is no
good. Therefore, you have to decrease
your cash by this check amount.
DESCRIPTION DEBIT CREDIT
? 75.00 -
Cash - 75.00
Look at the Accounting Format. A decrease to Cash is going to
require a credit entry. This means,
automatically, that you are going to have to debit some other entry for
$75.00. What’s it going to be? You have to ask this question in your mind to
start formulating the answer. Go back to
the original transaction. You sold
something to this customer and they paid you.
When that happened, you increased Sales and increased Cash.
Keep looking at the Accounting
Model. An increase to Sales is
what? Yes, it’s a credit. The sale
turned out to be no good, so you have to negate it. You do that by decreasing Sales and you do
that by debiting that account.
DESCRIPTION DEBIT CREDIT
Sales 75.00 -
Cash - 75.00
Weren’t you looking for a
debit? See how this works, it’s kind of fun.
See how important it is to memorize the Accounting Model!
(source : John W. Day, MBA)
