Double-entry accounting is the transaction bookkeeping principle for which hold accounting equation remains balanced. For this reason, each transaction will affect at least two accounts.
The accounting equation states that assets are the sum of liabilities and shareholders’ equity. Assets represent the company’s resources. Meanwhile, liabilities and equity represent the claims of creditors and shareholders for these resources, respectively.
Assets = Liabilities + Shareholder equity
Furthermore, to remain balanced, when an account in the asset changes, an equal amount of the change will occur in the liability or equity. Or, another account in the asset changes in the opposite direction.
Examples of double-entry accounting
Case 1: The company buys a machine for Rp500 million in cash to increase production capacity.
The company reports fixed asset accounts increased by Rp500 million, and cash decreased by Rp500 million. Because both are components of assets, the total asset is unchanged.
Case 2: The company buys Rp100 million in raw materials on credit from the supplier.
For this transaction, the company records an increase in inventory by Rp100 million and an increase in trade payable by Rp100 million. Stock is in assets, while trade payable is in liabilities, so the equation remains equal.
Case 3: The company sells 50 products for Rp7.5 million. Of this total, the customer pays Rp3 million in cash and pays in installments for the rest. Furthermore, the sale spends Rp5 million in inventory.
Regarding the transaction, the company records an increase in cash of Rp 3 million. The company also reports an increase in trade receivables of Rp.4.5 million. Furthermore, the inventory account decreases by Rp5 million. All three are recorded in current assets so that in total, the company’s asset value has increased by Rp2.5 million.
In the income statement, the company books revenue of Rp7.5 million and the cost of goods sold of Rp5 million. Assuming the income and other expenses are unchanged, the company books a net profit of Rp2.5 million. The net profit increases owner’s equity by Rp2.5 million through an increase in retained earnings (assuming no dividend payments).
Why it is important
Double entry is the basis for financial transaction accounting and reporting. The company records every transaction in the form of debit and credit. When the company records credit in one account, the company will also record debits in another account. Thus, the total amount of credit must be equivalent to the total debit.
Such a bookkeeping system makes it easy to prepare accurate financial reports. You can also more easily detect errors.
The company records on the debit side when a transaction causes an asset or expense account to increase. Also, transactions that cause a decrease in liabilities or equity are recorded on the credit side.
Conversely, when a transaction decreases assets or expenses, the company records it on the credit side. The credit side recording also applies when the transaction increases the liability and equity account.