The most scientific and reliable method of accounting is Double Entry System. One must have a clear conception about the nature of transaction to understand double entry system.
Every transaction involves two parties or accounts – one account gives the benefit and the other receives it. It is called dual entity of transaction.
In every transaction the account receiving benefit is debited and the account giving benefit is credited.
The process of keeping account accepting this dual entity i.e. debiting one account for a definite amount of money and crediting the other account for the same amount is called double entry system.
Every transaction effects the accounting equation of a business. Dual change may take place between two assets.
For example, machinery purchase in cash. Here machinery account receives the benefit and the cash account gives the benefit or the amount of decrease in cash will give increase of machinery for the same amount. Again this change may take place between two liabilities.
For example; to meet up the claim of creditor taking long term loan. Here long term liability is credited abolishing the short term liability of creditor. Besides, this change may take place between asset and liabilities.
For example; furniture purchased on credit. Here asset is debited for particular amount and at the same time equal amount of liability is also credited.
Since every transaction brings changes in assets for equal sum of money or asset and liability or liabilities, the transactions are to be recorded according to double entry system to know the accurate, position of assets and liabilities of a business concern.
If accounts are maintained under double entry system two accounts are effected. One is debited and another is credited. This is the main principle of double entry system. To make the matter clear some examples are given below;
Mr. Angel invested cash $20,000 in his business as capital. This transaction involves two accounts – Cash Account and Capital Account – Angel. For this transaction asset-cash increases for $20,000 in one side and on the other side liability increases for $20,000 as capital which is the claim of the owner.
This transaction is to be recorded debiting cash and crediting capital accounts. If the transactions are not recorded in two accounts proper results are not reflected.
Furniture purchased for $2,000. This transaction involves two accounts – furniture account and cash account.
For this transaction cash decreases for $2,000 and furniture increases for $2,000. Here, furniture account is debited and cash account is credited for $2,000 cash. In other way the transaction changes only. An element of accounting equation i.e., A = L + P.
It is clear from the above discussion that every transaction is to be recorded in two accounts – one is debited and other is credited.
The main principle of double entry system is that, for every debit there is a corresponding credit for equal amount of money and for every credit there is a corresponding debit for equal amount of money; i.e. for every transaction one account is debited for the amount of transaction and the other account is credited for the equal amount of money.
Therefore, it can be said that the system under which every transaction is accounted in two accounts for equal amount of money debiting one and crediting the other ignoring no account is called double entry system.
Some important definitions of double entry system are quoted below:
William Pickles says, “Double Entry system seeks to record every transaction in money or money’s worth in its double aspect – the receipt of a benefit by one account and the surrender of a like benefit by another account, the former entry being to the debit of the account receiving the later to the credit of the account surrendering.”
R. N. Carter says, “Every debit must have-a corresponding credit and Vice – Versa.”
Stephen says. “Double entry Book-Keeping is a system by which every debit entry is balanced by an equal credit entry.”
Characteristics or Fundamental Principles of Double Entry System
Double entry system is; a scientific, self-sufficient and reliable system of accounting. Following some widely accepted characteristics or principles account is kept under this system.
As a result in one side arithmetical accuracy of transaction is ensured and on the other side ascertainment of financial position of the business is easily possible. Characteristics of Double Entry System are stated bellow;
- Two parties: Every transaction involves two parties – debit and credit. According to the main principles of this system every debit of some amount creates corresponding credit or every credit creates corresponding debit for the same amount.
- Giver and receiver: Every transaction must have one giver and one receiver.
- Exchange of equal amount: The amount of money of a transaction the party gives is equal to the amount the party receives.
- Separate entity: Under this system business is treated as a separate entity from the owner. Here the business is considered as a separate entity.
- Dual aspects: Every transaction is divided into two aspects. The left side of the transaction debit and the right side is credit.
- Results: Under double entry system totality of debit is equal to the totality of credit. In it ascertainment of result is easy.
- Complete accounting system: Double entry system is a scientific and complete accounting system.
Through this system account is kept completely and no party is ignored. In fine it can be said that every transaction must possess these characteristics.
If there is any exception to this complete information will not be available in the books of accounting. As a result the main objective of accounting will be frustrated.
Process of Keeping Accounts under Double Entry System
- Journal: At first transactions are recorded in the primary book of accounting called journal.
- Ledger: In the second phase transactions are classified and recorded permanently in the ledger in brief.
- Trial balance: In third phase the arithmetical accuracy of the account is verified through preparation of trial balance.
- Financial statements: In fourth or final stage through financial statements the results of all the financial activities of a year are determined.
Advantages of Double Entry System
Double entry system is the most scientific method of keeping accounts. In the modem age this system is accepted as the best one.
In every organization whether big or small accounts are kept under double entry system. The advantages of double entry system are stated in brief;
- Complete accounts of transactions: Double entry system can keep complete accounts of transactions as it is based on dual aspects of each transaction; i.e. debit and credit are recorded simultaneously. For this reason, this system maintains accounts of all parties relating transactions.
- Verification of arithmetical accuracy: Arithmetical accuracy of accounting can be verified through preparation of trial balance if the accounts are maintained under double entry system. Under this system every debit for certain amount of money will have corresponding credit for equal amount.For this reason total amount of debit will be equal to the total amount of credit. It can be detected through trial balance whether two sides of accounts are equal or not and thereby arithmetical accuracy of the account is verified.
- Determining profit or loss: Under double entry system profit or loss of company for a particular accounting period can be known by preparing income statement. Since all accounts relating to income and expenditure are maintained properly in the ledger under double entry system, it becomes convenient to draw income statement at the end of particular accounting period.
- Determining financial position: Under double entry system total assets and liabilities of a business concern are recorded properly.As a result at the closing day of accounting period balance sheet is prepared with the help of all assets and liabilities. Through this balance sheet financial position of the business concerned can be ascertained.
- Knowing asset and liabilities: Total amount of assets and liabilities can be ascertained if the account is kept under double entry system and it becomes easier to settle liability and assets.
- Fixation of price of commodities: It becomes easier to fix-up the price of commodities as the accounts are maintained systematically under double entry system.
- Submission of income and VAT statements: Double entry system being the reliable system of keeping accounts the submission of reliable income and VAT statement under it are possible on the basis of which income tax and VAT are fixed and paid.
- Comparative analysis: Under this system of accounting future course of action can be formulated comparing income -expenditure, asset and liability of the current year with that of previous year.
- Increase in profit: Under this system of accounting the picture of all incomes or profits is reflected.It can be identified which item is more profitable for a business comparing the items relating to profit of the current year with that of previous year. In this way attempts can be made in order to make more profit.
- Expenditure control: Through comparative analysis expenditure may be controlled curtailing expensive expenditure.
- Detection and prevention of forgery: Under this system of accounts errors or forgery of accounts can easily be detected. As a result moral qualities of accountant and other employees are upheld.
- Supply of information: This system helps run business properly supplying necessary information and statistics to the management.
- Future reference: Under this system as every transaction is permanently recorded properly and completely, any necessary information can be detected easily in future.
- Easy application: It is easier to record the transactions properly in the books of accounts following scientific method of double entry system.
- Generally accepted method: Double entry system being a scientific method is a generally accepted system. The accounts under double entry system become reliable and acceptable to all concerned like income tax authority, creditors etc.
- Efficiency evaluation of business concern: Capacity for earning profit and repaying liabilities can be evaluated with the help of various ratios relating to accounts from financial statements.For example, creditors or loan givers evaluate the loan repaying capacity of a business concern with the help of current ratio. If the ratio is 2:1 then it is assumed that the loan repaying capacity of the business concern is sound enough.
- Timely step for correcting accounting errors: Accounting errors can properly be detected and taking necessary measures for correction is possible under double entry system of accounting; i.e. before going to next stage the errors of accounting can be corrected.
- Utility: The utility and application of this system in the accounts of all business concerns whether big, medium or small are accepted by all.
Disadvantages or Limitations of Double Entry System
Double entry system is a generally accepted scientific method. In spite of its many important advantages some limitations of it exist which are stated below:
- Increased size of books of accounts: Under double entry system every transaction is recorded in two sides of two accounts and in two steps (Journal & ledger) of books of accounts.
- Complexity in accounting process: Complexity arises in following rules, principles, techniques, and methods etc. for keeping accounts under double entry system.
- Expensive, time and labor consuming: Since accounting process under double entry system is extensive, a good number of books are to be kept and a large number of employees are employed for accounting work.As a result it requires enough labor, time and money. Therefore, it becomes impossible to follow this system by the small business concerns.
- Persons of specialized knowledge required: The accountant should possess both theoretical and practical knowledge of accounting for proper keeping of accounts under double entry system. An inexperienced person in accounting fails and faces problems in maintaining accounts under this double entry system
- Possibility of mistake: As the accounting process under double entry system is complex and complicated, the possibility of errors and mistakes cannot be avoided completely.
- Limited scope of application: In small business organization, daily shopping, cultural ceremony the application of single entry system of accounting is more popular and advantageous than double entry system.
- Problem in maintaining secrecy: A lot of people are engaged in maintaining accounts under double entry system since the accounting process is very wide and extensive. As a result problem arises in maintaining secrecy of the accounts or business.
Though there arises some problems in maintaining accounts under double entry systems, its advantages and acceptability are so wide and comprehensive that at present age in almost all field accounts is kept under this system.