Every business organization has two facets associated with it. What is given out has a taker in itself, and every transaction has a loss and a gain associated with it.
As per the double entry system of bookkeeping, there are two accounts associated with any business organization. Introduced by Italian Lucas Pacioli in 1494, this system was primarily developed in England and has been regularly used in that country.
Understanding the double entry system:
The double entry system specifically involves two accounts such as cash account, which to a great extent would be increased and liability account where those loans that are to be paid would increase.
Basing itself on the concept of, ‘’Somebody’s loss being another person’s game’’, it is imperative that there are double accounts in consideration of credit entry system.
As per the American measuring standards, every business transaction is specifically associated with liability, asset, expenses and revenue in a collective manner or individual manner. In every business transaction either there is an increase or a decrease in total range. Whereas increase in assets and expenses are debited, on the one hand, decrease in assets and expenditure are credited on the other. Other changes in debit and credit work in an according manner.
The point of recording debit and credit system in regards to same amount is the primary aspect of double entry system.
There are certain specific features that are associated with this concept:
- Double accounts are to be affected:
The most important aspect associated with this system is the presence of dual accounts, the credit, and debit system. Though certain transactions have more than two accounts in specific cases, however, the amount pending both on credit and debit account tends to be similar.
- There is dual aspect in every transaction:
It is to be noted that every debit has a specific credit associated with it, hence when counting is made it both these accounts are taken into consideration in a simultaneous matter.
- Account is to be divided into two specific parts:
There are books of original account as journal and subsidiary against which the ledger account is to be placed. The left side is taken as debit while right side can be taken as credit.
- Segregation of amount column:
This amount column is specifically divided into Debit side and Credit side.
- Accounting concepts and convention:
To maintain the book of accounts in a correct manner, in most cases, the double entry system is followed.
- Preparation of trial balance:
There are two stages of recording in a double entry system. Initially, every business transaction is recorded in a subsidiary book or a journal. It is based on accounting details of these books that ledger accounts are prepared. Details from this ledger accounts are now specifically used for preparing trial balance and which itself tests arithmetical accuracy of accounting that has been made.
- Preparation of final accounts:
It is the final accounts that are prepared that helps in determining profit and loss aspects of a particular business organization. Trial balance that is prepared based on balance of ledger accounts has both credit and debit balances associated with it. When equated, it can be found that both these columns have similar end results.
In case of Income statements as Trading, Profit and Loss account as well, there are specific credit and debit sides associated. Such division can be seen in case of Balance sheet as well, and this preparation of data and presentation of that in a categorical manner depicts usage of a specific Double Entry System in case of accounting.
Positives associated with Double Entry System:
There are certain specific advantages that are associated with this system of accounting which ensures that every detail available can be used for further compilation of financial details.
- Detailed information of the records:
Since business deals are associated with assets, expenses, revenue, capital and liabilities on a greater note, hence with help of this system a detailed note can be maintained, which can also act as a reliable fall-back option in case of any discrepancy.
- Complete details of profit and loss:
With help of this double entry system, the Trading Account can be formed which is associated with deriving the gross profit and loss amount. Also, with Profit and Loss account that is framed with help of this system, net profit or loss that an organization has incurred can also be seen.
- Detailed knowledge of assets and liabilities:
The Balance Sheet that is prepared helps in segregating assets and liabilities and keeping track of the company’s financial position.
Since there is a detailed description of assets and liabilities as well as profit and losses incurred by a company, hence chances of any unaccounted income or expenditure can be immediately brought to notice.
- Comparative studies:
With the help of a Balance Sheet that is prepared with double-entry system, financial statements can be both compared on an annual basis as well as comparative analysis of actual performance obtained against desired performance.
Problems associated with Double Entry System:
These are certain areas which do not have any solution when this system is being used.
- Errors of principle:
Since this system is specifically associated with balancing credit and debit side, hence it does not have capacity to check out discrepancies when cash sales account is being debited from cash account.
- Errors of omission:
The major issue associated with this form of accounting is that, in case of detecting errors, it is important that there be a detailed format. In case of any discrepancy, if the recording is not available in the book, then it is very difficult to find out errors.
- Compensation of errors:
Since this system is based on equating of credit with debit accounts, it may so happen that when a particular account is credited with a certain amount of money, another account is debited for the same amount. Though, equality of both accounts can be obtained, but this mistake remains.
Basis of Accounting:
When the concept of revenue is to be introduced in regards to Accounting, it is important to understand timing associated with the revenue along with incurred costs.
This can be differentiated as Cash Basis and Accrual Basis.
Defining Accrual Basis:
In case of this system, both cost and revenue are taken into consideration in its period of occurring rather than its period of actual payment. Technically speaking, revenue and cost are generated only at a time when legal right and obligation to make and provide payment is recognized.
Since this format takes into account date of transaction matching of revenue can be done which can also help in determining actual revenue that is earned during this period.
Example: Generally, credit sale for the month of October 2006, is to be recognized only in January 2007, but it will be recorded in the Books of Accounts in the month of October 2006 itself. In case of salary itself, it will be taken into consideration in the month of November 2006 itself.
Defining Cash Basis:
In this case, cost is said to be recognized though actual payment and receiving is done in the form of cash. Since, this mode is applied only when there is doubt regarding actualization of payment that is to be made, so for sales on hire, payment is made on the basis of installment over a limited period. Sales for those parts are to be complete which has received its expected payment. In case of government organizations as well as professionals, account is prepared in this cash basis.
Example: When salary for month of November 2006 is paid on December 2006, date recorded in Book of Accounts would be of December 2006. Also, credit sale rather than being recorded on date of sale would be recorded on date on which payment has been received.
However the major backlog of this system rests in the fact that in this case revenue is matched with cost to get actual profit rate.
A detailed understanding of this Double Entry system is to be understood for better application of its concepts.