Double entry system of accounting

Content:

• A brief history of double entry system accounting
• Definition and explanation
• Advantages and disadvantages

A brief history of double entry accounting

The first book on double entry system of accounting was written by an Italian mathematician Fra Luca Pacioli and his close friend Leonardo da Vinci. The book was entitled as “Summa de arithmetica, geometria, proportioni et proportionalita” and was first published in Venice in 1494. Pacioli and da Vinci did not claim to be the inventors of double entry accounting but they explored how the concepts could be used in a more efficient and organized way.

Pacioli wrote the text and da Vinci drew the practical illustrations to support and explain the text in the book. The book was divided into various sections and the one that talked about double entry system was entitled as “Particularis de computis et scripturis”. It was further divided into many small chapters/sections describing double entry, journals, trial balance, balance sheet, income statement and many tools and techniques which were subsequently adopted by many accountants and traders.

Before pacioli’s contribution, some form of double entry system of accounting was already in practice. No one exactly knows when and how it was invented. However, it was pacioli’s book that introduced the system in Europe and other trading countries of the world. As the acknowledgement of his work, Pacioli is known as the “father of accounting” by modern accounting professionals.

Definition and explanation

The double entry system of accounting or bookkeeping is based on the fact that each business transaction essentially brings two financial changes in business. These changes are essentially recorded as debits or credits in two or more different accounts using certain rules known as rules of debit and credit. In double entry system of accounting, every debit entry must have a corresponding credit entry and every credit entry must have a corresponding debit entry. It is the basic principle of double entry accounting and there is no exception to it. For example if a business purchases furniture for $500 cash, the value of total furniture is increased by $500 and at the same time, the cash amounting to $500 is decreased. If the business is using double entry system of accounting, it must debit the furniture account by $500 and credit the cash account by $500. To understand why the business would debit furniture and credit cash – see the ‘debit and credit rules’ page.

The double entry system of accounting can be broadly divided into the following three stages:

1. Original records (journal or subdivision of journal)
2. Classification (ledger accounts)
3. Summary (final accounts)

1. Original records (journal and subdivision of journal):

The business transactions are first recorded in a book called journal which is further divided into various subsidiary books such as general journal, cash receipts journal, cash payments journal, purchases journal, purchases returns and allowances journal, sales journal, sales returns and allowances journal etc. The number of subsidiary books to be maintained by a business depends on its nature, size and volume of transactions.

2. Classification (ledger accounts):

In the second stage, all transactions relating to the same person or thing are collected and stored in one statement called account. The book in which these classified accounts are kept is known as general ledger or ledger for short. A ledger account can be checked at any time to see the additions and reductions of particular item to which the account relates. The cash account, for example, would reveal the inflows (i.e., additions) and out flows (i.e., reductions) of cash during a particular period of time.

3. Summary (profit and loss account and balance sheet):

After certain periods, the ledger accounts are balanced and a statement called trial balance is prepared which is further used for determining profit or loss and accessing the financial position of the business. The profit or loss of the business is determined by preparing an account known as profit and loss account or by preparing a statement known as income statement. The financial position of the business on a certain date is evaluated or determined by listing assets and liabilities in a balance sheet.

Advantages and disadvantages of double entry accounting

Advantages or merits

The major advantages or merits of employing a double entry system of accounting in businesses are listed below:

1. Under double entry system of accounting, the two aspects of each transaction are recorded (i.e., for every debit there must be a credit and vice versa). It creates an equilibrium within the records which helps in detecting errors, omissions and frauds.
2. Under this system, a trial balance can be prepared to check arithmetical accuracy of all accounting entries. The trial balance can be further used for finding out operating results by preparing income statement and determining the financial position of the business by preparing a balance sheet.
3. Double entry system is the most advanced and useful form of maintaining accounting records and is extensively used by companies worldwide. Without this system, a company would not be able to compare its financial statements with that of other companies.
4. Double entry system is highly systematic that follows certain rules and principles; so it is easy to track information about a particular transaction or account quickly when needed by owners, management, accountants or other employees.
5. Almost all accounting standards, frameworks and laws applicable worldwide require the use of double entry system of accounting. If a company fails to comply with this requirement, the auditors would not accept its financial statements.
6. The financial reports and results generated by double entry system is reliable to great extent for decision making purpose.

Disadvantages/demerits of double entry system

The major disadvantages or demerits of using a double entry system of accounting are as follows:

The double entry system is complex enough to require skilled and qualified employees to handle the whole process of maintaining accounting records. Its employment may be costly, time consuming and therefore inconvenient for sole proprietors and other small businesses.

The advantages of double entry system far outweigh its disadvantages. Double entry system has, therefore, become the standard and, in many cases, a basic requirement for maintaining accounting records of medium and large sized business enterprizes. Most of the today’s manual and computerized accounting systems are based on it.