<< Double Entry Accounting – Basics

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In these examples, we will continue to focus on the descriptions and the amounts of financial transactions so we will be making entries in a 3 column grid where the left column is for descriptions and the two remaining columns are numeric and are for debits and credits.

Since we’re focusing on only three aspects of the transaction, the three questions that must be answered for each financial transaction in double entry are:

1.  What is the value of the transaction in terms of dollars (how much money changed hands)?

2.  Where did the money go – What was gained or paid for by the exchange?

3.  Where did the money come from – what is the source of the value in this exchange?

The amounts that are associated with question 2 are always entered in the debit (left numeric) column and the amounts associated with question 3 are always entered in the credit (right numeric) column.

Money is not always directly involved in a transaction.  Sometimes the transaction involves a trade or sometimes it involves a money substitute, a promise of future money transfers – as with credit card purchases – but something of value is always exchanged for something else of value in a financial transaction.

In the previous post, the transaction was very simple and money was involved, there was a $3,000 rent charge that was paid in full from the checking account.

What about in the case of a credit card statement where there are many different types of charges made to one credit card.

Answer 1 :            Total Charge on Statement = 2,500
Answer 2a:           Office Supplies
Answer 2b:           Fuel
Answer 2c:           Tires
Answer 2d:           Subscriptions
Answer 2e:           Printer
Answer 3 :            Credit Card

In this case, since there are multiple answers for question 2, the descriptions and the amounts related to each separate part of the answer are listed on separate lines but the total amount associated with Question 2 and with Question 3 will always be equal.

Sometimes the promise of future money is not a debt to be paid by you but a debt to be collected by you as in the case of a sale where you bill the customer.

Answer 1:  50,000   (The amount of the transaction)

Answer 2:  Accounts Receivable   (What was gained?  In this case the gain was a short term promise to pay.)

Answer 3:  Sales (Where did the money come from?  What is the source of the value?)

*for readability: traditionally, debits entries are listed above credit entries and the description for the credit entries are traditionally indented.

Double Entry requires a minimum of two lines, or accounts, to fully describe a financial transaction.  In cases where there are multiple answers to one of the questions, the term Double Entry can seem like an inaccurate description but Double Entry does Not refer to the number of lines or accounts required to record the transaction.  It refers to the left/right entries where the full amount of the transaction must be entered in the debit column and again in the credit column – double entry – regardless of the number of lines required to fully describe the transaction.  The philosophy of Double Entry is a balanced financial picture requiring that both the Uses and Sources of funds be recorded.  Debits, Credits and Accounts are just part of the Structure that helps to ensure that balance.

This post completes the most important concepts of double entry accounting transactions. Once transactions are posted, the Chart of Accounts helps to organize and summarize them.  The next post, explains the basics of the Chart of Accounts.

Next Up: >>Chart of Accounts – Basics

<< Double Entry Accounting – Basics

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

<< Accounting Overview

>>Double Entry Accounting – More Transactions

The purpose of Accounting is to provide feedback about the financial position and activities of you and/or your investments and businesses. The reason to learn about it is so that you can understand the feedback and put it to work for you.

The feedback element of Accounting takes the form of Financial Reports and in order for you to rely on those reports, it is important to have a consistent and reliable system for gathering and organizing the information those reports are produced from.

The Double Entry System has endured since at least the 12th century because it is a simple, consistent and reliable system of gathering and organizing information and producing financial reports for financial management and for tax and reporting purposes.

The first task of the system is to gather data from financial transactions. Financial transactions are exchanges of things of value. Even if money is not part of the exchange, a dollar value must be used to represent the exchange.  Since a dollar value must represent the value of each exchange, I’ll often use the terms “money” or “funds” when referring to the value of each financial transaction.

In this post, I’ll explain the method of collecting and posting financial data in the Double Entry Accounting System.  The entire Double Entry System is built around the concept of balance, recording both the Use and the Source of funds.  Once the Double Entry concept is understood, the whole system of data collection, organization and summary is easily understood.  This method is standard and works the same way each time, no exceptions.

There are three basic questions that must be answered for the double entry accounting transactions, they are:

Question 1. How much money changed hands? What is the value of this exchange?

Question 2: Where did the money go?  How was the money used?  What was either gained or paid for by this exchange?

Question 3: Where did the money come from? What is the source of the value in this exchange?

Example 1:

Answer 1: 3,000.00
Answer 2: Rent
Answer 3: Checking Account

The answers for each of these questions are recorded in a grid. The columns of the grid collect a variety of information but for the purpose of this discussion, we’ll use three columns. One column for descriptions and two numeric columns for amounts. The left numeric column is called the “debit” column and the right numeric column is called the “credit” column.

The descriptions that answer questions 2 and 3 are always entered on separate lines to the left of the two numeric columns.

The amount associated with question 2 is entered on the same line as its description and it is always answered in the left (debit) numeric column. The amount associated with question 3 is entered on the same line as its description and it is always answered in the right (credit) numeric column.

You see that the amount from question one is entered twice (double entry), once in the Debit Column and once in the Credit Column.  If you have answered all three questions for each transaction and both columns always add up to the same number, your books are in balance. This brings us to the most basic rule of accounting.

Rule # 1: Total Debits = Total Credits

To recap: Accounting requires that for each financial transaction, the basic questions of how much money is involved, where the money went and where the money came from are answered.

In order to ensure that these questions are always answered for each transaction, the Double Entry System is used.  The Double Entry Transaction System is a multi-line, two numeric columned system. The left numeric, or “debit” column is always the “where did the money go – what was gained or paid for” column and the right numeric, or “credit” column is always the “where did the money come from – what is the source of value” column. The total of one column must always equal the total of the other.

Double Entry does Not refer to the number of Accounts or Lines required to record a transaction.  Double Entry refers to Debits and Credits (two sides = double).  If you have fully described both the Use and the Source of Funds, you have accomplished the objectives of Double Entry.

Next up: >>Double Entry Accounting – More Transactions

<< Accounting Overview

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.