Definition of Double-Entry Bookkeeping
Double-entry bookkeeping is an accounting system that records each financial transaction in at least two accounts: one account is debited and another is credited for the same amount. This method maintains the fundamental accounting equation—assets equal liabilities plus equity—ensuring that the total debits always equal total credits across all accounts.
Key Principles and Components
The core principles revolve around debits and credits: debits increase assets or expenses and decrease liabilities, equity, or revenue, while credits do the opposite. Transactions are first entered in a journal and then posted to a ledger, with trial balances used to verify accuracy. This dual recording prevents errors and provides a complete financial picture.
Practical Example
Consider a business purchasing $500 worth of office supplies for cash. In double-entry bookkeeping, the transaction is recorded as a debit to the Office Supplies account (increasing assets) for $500 and a credit to the Cash account (decreasing assets) for $500. This entry balances the books and reflects the exchange accurately.
Importance and Applications
Double-entry bookkeeping is essential for producing reliable financial statements, such as balance sheets and income statements, which are crucial for decision-making, tax compliance, and auditing. It is widely applied in businesses of all sizes to detect discrepancies early and ensure financial integrity, forming the basis of modern accounting standards like GAAP.