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Explain double entry system
Maintaining two or more accounts for every single business transaction is called a double entry system. Each financial transaction has an effect on, at least, two accounts which are equal and opposite.
For example, suppose, if a debit transaction has happened in a business, then the same transaction has the opposite effect in other (credit) accounts.
The two essentials in the double entry system are debit and credit. Every debit entry is recorded on the left side of the ledger and every credit entry is recorded on the right side of the ledger. At the end, the amount on the debit side and credit side should be equal or the amount on the debit side is equal to the amount on the credit side.
- Debits (left side) − Increase in asset and expenses, decrease in liability, revenue and equity.
- Credit side (right side) − Increase in liability, revenue and equity, decrease in assets and expenses.
Characteristics
The characteristics of double entry system are as follows −
- Each debit entry creates a corresponding credit entry (or) each credit entry creates a corresponding debit entry for the same amount.
- In every transaction, there will be at least one giver and receiver.
- Amount given by one party is equal to the amount received by another party.
- It has separate entities and dual aspects.
- Debit (total) is equal to credit (total).
- It is scientific and completes an accounting system.
Under double entry system, accounts are kept in following steps −
Transactions are recorded in primary books (journal).
Every transaction is classified and recorded permanently (ledger).
Preparation of trial balance.
Preparation of financial statements.
Minimization of errors
Double entry system minimizes the errors by balancing credit and debit sides. By using the equation, assets are equal to liabilities plus shareholders’ equity, errors are found and corrected. This reduces the complexity of errors.
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