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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 balanced data from financial transactions - to record both what was gained or paid for and the source of funds. 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: 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 money in this exchange?
- Answer 1: 3,000.00
- Answer 2: Rent
- Answer 3: Checking Account
The answers for each of these questions are recorded in a journal that has a grid format. 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 money” 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.
© 2008 - 2010 Erin Lawlor
**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.