DOUBLE ENTRY THEORY: WHAT IT IS, RULES, APPLICATIONS, EXAMPLES - ECONOMY - 2024

The theory of double entry establishes that for each commercial transaction the amounts must be recorded in a minimum of two different accounting accounts, having the opposite effect on these accounts.

In addition, it is required that the values ​​recorded as credits must be equal to the values ​​recorded as debits for all transactions. It is used to satisfy the accounting equation: Assets = Liabilities + Equity.

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The debit corresponds to a record on the left side of the account ledger, and the credit corresponds to a record on the right side of the ledger. With the double entry system, credits are reconciled with debits in the general ledger or in a T account.

Therefore, since the credit in one account will always be equal to the debit in another account, the total of the credits must be equal to the total of the debits.

This theory makes preparing formal financial statements easy. It is a fundamental concept in accounting today.

What is the double entry theory?

Every commercial transaction has two effects. For example, if someone buys a drink at a local store, paying cash to the merchant will receive a bottle of soda for this payment. This simple transaction has two effects, both from the perspective of the buyer and the seller.

On the side of the buyer, buying the bottle of soda will reduce your cash amount for the cost of it. On the seller's side, you will have a reduction in your soft drink inventory, but your cash amount will increase by the value of the price of the drink.

Accounting establishes these effects of the transaction in the financial statements of a company. This is the application of the double-entry theory.

Reflect a total view of the transaction

If the double-entry theory were not employed, the accounting would only show a not complete picture of the entity's transactions.

For example, a company purchased equipment, but the accounting records do not state whether the equipment was purchased for cash or on credit.

Perhaps the machine was bought in exchange for another machine. Such information can only be obtained from accounting records if both effects of the transaction are taken into account.

Commonly, the two effects that an accounting entry has are called debit and credit.

Rules

In accounting you just have to learn the rules of the double entry theory "by heart", everything else must be reasoned. The essential rules are as follows:

- The one who delivers is the creditor and the one who receives is the debtor. Everything that is delivered is credited and what is received is debited.

- There is no creditor without a debtor, and no debtor without a creditor.

- The items recorded in the accounts must be of the same nature. All concept credited by an account must be debited by the same account or vice versa.

- A debit is always on the left side of a transaction and a credit on the right side.

- The total of the debit must be equal to the total of the credit.

- The accounts that are debited mean: an increase in assets, a reduction in liabilities or a reduction in equity.

- The accounts that are credited mean: a reduction in assets, an increase in liabilities or an increase in equity.

- Profits are credited and losses are debited.

Balance equation

The double entry theory is the basis for the balance sheet, since total assets equals total liabilities plus equity of a company.

Therefore, the accounting equation Assets = Liabilities + Equity represents the platform for double-entry accounting. It is a concise form of the concept expressed in the complex presentation of multiple balance sheet items.

Applications

Check arithmetic precision

Through a trial balance it will be possible to detect whether the two sides of the accounts are equal or not, thus verifying the arithmetic precision of the accounts.

Determine profit or loss

The profit or loss of the company for an accounting period can be known by preparing an income statement.

Since all accounts related to income and expenses are properly kept in the general ledger, it is convenient to extract the income statement at the end of a particular accounting period.

Determine financial position

Under this theory, the total assets and liabilities of a company are correctly recorded. As a result, at the end of the accounting period, the balance sheet is prepared with the help of all assets and liabilities.

Through this balance, the financial position of the company in question can thus be determined.

Submit income and VAT declaration

Under this theory it is possible to reliably present income and also the VAT return. On this basis, income tax and VAT are set and paid.

Comparative analysis

The future course of action can be formulated, comparing the income, expenses, assets and liabilities of the current year with those of the previous year. In addition, you can control spending, reducing high costs.

Examples

If a company receives a loan from a financial institution, the money borrowed will increase the assets of the company and the liability for the loan will also increase by an equivalent amount.

If an organization purchases raw materials and pays for it in cash, this will generate an increase in inventory, which is an asset, and on the other hand, it reduces the amount in cash, which is another asset.

Buy trucks on credit

A bakery buys a fleet of delivery trucks on credit. The total purchase on credit was $ 200,000. The new set of trucks will be used in commercial operations and will not be sold for at least 10 years, which is their estimated useful life.

In order to account for the credit purchase, the records must be made in the respective accounting books.

Because the business has accumulated more assets, the fixed asset account will be charged for the cost of the purchase ($ 200,000).

To register this purchase on credit, a credit entry for $ 200,000 is made in the accounts payable.

Registering the debit increases the value of the fixed asset. On the other hand, the credit registry increases the value of the liability owed by the same amount.

Double entry can also occur within the same category. If the purchase of the bakery had been made in cash, a credit to the cash account and a debit to the fixed asset would be recorded, still resulting in a balance.

References

1. Adam Hayes (2019). Double Entry Definition. Investopedia. Taken from: investopedia.com.
2. Harold Averkamp (2019). What is the double-entry system? Accounting Coach. Taken from: accountingcoach.com.
3. Accounting Simplified (2019). Concept of Double Entry. Taken from: accounting-simplified.com.
4. University of La Punta (2019). Principles of Double Play. Taken from: contentsdigitales.ulp.edu.ar.
5. Iedunote (2019). Double Entry System: Defined, Features & Principle Explained. Taken from: iedunote.com.