By Carol Wiley, Accountingedu contributing writer
Updated April 2013
The simplest type of accounting system involves simply making a list of income and expenses recorded when a cash transaction occurs--that’s called single entry (or cash) accounting.
In contrast, a double entry accounting system consists of a chart of accounts where every financial transaction is recorded into at least two of the accounts, once as a debit and once as a credit. This is done to add an additional layer of verification to further ensure the accuracy of the accounting.
The advantages of single entry (cash) accounting is that it's simple and provides information needed for income tax purposes. However, single entry accounting offers a limited ability to track financial performance and do financial analysis.
Although double entry accounting is more complex, it also has a number of advantages, including an automatic way to catch arithmetic mistakes. Also, accrual adjustments are automatic, whereas in single entry accounting, they have to be made manually. Double entry accounting provides detailed financial information for tracking financial performance and producing the income statement and net worth statement.
Setting up a double entry accounting system consists of setting up a chart of accounts in a general ledger. There are five basic types of accounts made up of three balance sheet accounts (assets, liabilities, and equities) and two income statement accounts (revenue and expenses).
When a financial transaction occurs, entries are made in at least two of the accounts on the chart of accounts. In a general ledger chart of accounts, debits are recorded on the left side and credits are recorded on the right side.
The left side must always equal the right side.
The basis of double entry accounting is the equation:
Assets + Expenses = Liabilities + Equities + Revenues.
Increases in assets and expenses are left side entries (debits) in the chart of accounts, and increases in liabilities, equities, and revenues are right side entries (credits). Here are three example entries:
(This entry represents an increase in assets (cash) and an increase in owner’s equity.
(This entry represents an increase in assets (merchandise) and an increase in liabilities (accounts payable)).
(This entry represents an increase in expenses (office supplies) and a decrease in assets (cash)).
Here’s a slightly more complex example: A business sells $5,000 in merchandise (that cost the company $2,500), and the customer pays $3,000 at the time of the sale.
|Cost of Merchandise Sold||$2,500||-|