Mechanics of Double-Entry Bookkeeping
With double-entry bookkeeping, you can calculate the account balance for any account by taking the starting account balance and then adding the debits and credits that have occurred since then. By hand, this arithmetic is a little unwieldy. Your computer (with the help of QuickBooks 2012) does this math easily.
Roughly 500 years ago, an Italian monk named Pacioli devised a systematic approach to keeping track of the increases and decreases in account balances. He said that increases in asset and expense accounts should be called debits, whereas decreases in asset and expense accounts should be called credits.
He also said that increases in liabilities, owner’s equity, and revenue accounts should be called credits, whereas decreases in liabilities, owner’s equity, and revenue accounts should be called debits.
Using Pacioli’s debits and credits system, any transaction can be described as a set of balancing debits and credits. Not only does this system work as financial shorthand, but it also provides error checking. To get a better idea of how this works, look at some simple examples.
Take the case of a $1,000 cash sale, for example. Using Pacioli’s system, or by using double-entry bookkeeping, you can record this transaction as shown here:
Cash $1,000 debit
Sales revenue $1,000 credit
See how that works? The $1,000 cash sale appears as both a debit to cash (which means an increase in cash) and a $1,000 credit to sales (which means a $1,000 increase in sales revenue). Debits equal credits, and that’s no accident.
The accounting model and Pacioli’s assignment of debits and credits mean that any correctly recorded transaction balances. For a correctly recorded transaction, the transaction’s debits equal the transaction’s credits.
By convention, accountants and bookkeepers show transactions, or what accountants and bookkeepers call journal entries.
See how that works? Each account that’s affected by a transaction appears on a separate line. Debits appear in the left column. Credits appear in the right column.
You actually already understand how this account business works. You have a checkbook. You use it to keep track of both the balance in your checking account and the transactions that change the checking account balance.
The rules of double-entry bookkeeping essentially say that you are going to use a similar record-keeping system not only for your cash account but for every other account you need to prepare your financial statements, too.