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Double Entry System:

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Contents:

  1. Definition and explanation.

  2. Successive process of the double entry system.

  3. Advantages.

  4. Disadvantages.

Definition and Explanation of Double Entry System:

Every business transaction causes at least two changes in the financial position of a business concern at the same time - hence, both the changes must be recorded in the books of accounts. This concept is explained on Analysis of Business Transaction page. Otherwise, the books of accounts will remain incomplete and the result ascertained therefore will be inaccurate. For example, we buy machinery for $100,000. Obviously, it is a business transaction. It has brought two changes - machinery increases by $100,000 and cash decreases by an equal amount. While recording this transaction in the books of accounts, both the changes must be recorded. In accounting language these two changes are termed as "a debit change" and "a credit change" The detail about these terms is given under the topic account. Thus we see that for every transaction there will be two entries - one debit entry and another credit entry. For each debit there will be a corresponding credit entry of an equal amount. Conversely, for every credit entry there will be a corresponding debit entry of an equal amount. So, the system under which both the changes in a transaction are recorded together - one change is debited, while the other change is credited with an equal amount - is known as double entry system.

Locus Pacioli, an Italian wrote a first book on double entry system in 1494. It is regarded as the best and the only scientific method of accounting system universally accepted throughout the world. It has been built on well defined rules and principles which is the foundation of modern accountancy.

The fundamental principle of double entry system lies in analyzing the two changes (parties) involved in business transactions and properly recording of both the changes in the books of accounts. There is no exception to this principle. If a complete picture of the transactions is to be reflected through books of accounts, the double entry system must be duly observed. Otherwise the books of accounts will fail to provided complete information and the very objective of accounting will be defeated.

Successive Processes of the Double Entry System:

Following are the successive processes of the double entry system:

Journal:

First of all, transactions are recorded in a book known as journal. Read more about journal.

Ledger:

In the second process, the transactions are classified in a suitable manner and recorded in another book known as ledger. Read more about ledger.

Trial Balance:

In the third process, the arithmetical accuracy of the books of account is tested by means of trial balance. Read more about trial balance.

Final Accounts:

In the fourth and final process the result of the full year's working is determined through final accounts.

Advantages:

Double entry system is acknowledged as the best method of accounting in the modern world. Following are the main advantages of double entry system:

  1. Under this method both the aspects of each and every transaction are recorded. So it is possible to keep complete account.

  2. Since both the aspects of a transaction are recorded, for each debit there must be a corresponding credit of an equal amount. Therefore, total debits must be equal to total credits. In fact, it is possible to verify the arithmetical accuracy of the books of accounts by ascertaining whether the two sides become equal or not through a process known as trial balance.

  3. Under this system profit and loss account can be prepared easily by taking together all the accounts relating to income or revenue and expenses or losses and thereby the result of the business can be ascertained.

  4. A balance sheet can be prepared by taking together all the accounts relating to assets and liabilities and thereby the financial position of the business can be assessed.

  5. Under this system mistakes and deflections can be detected - this exerts a moral pressure on the accountant and his staff.

  6. Under this system necessary statistics are easily available so that the management can take appropriate decision and run the business efficiently.

  7. All the necessary details about a transaction can be obtained quickly and easily.

  8. The total amount owed by debtors and the total amount owed to creditors can be ascertained easily.

  9. Sale, purchase of goods, stock, revenue, expenses and profit or loss of different years can be compared and the success or failure of the business measured. Thereafter the causes of failure can be found out and necessary remedial measures taken to ensure success of the business.

Disadvantages:

Despite so may advantages of the system, double entry system has some disadvantages which are as follows:

  1. Under this method each transaction is recorded in books in two stages (journal and ledger) and two sides (debit and credit). This results in increase of number and size of books of account and creation of complications.

  2. It involves time, labor and money. So it is not possible for small concerns to keep accounts under this system.

  3. It requires expert knowledge to keep accounts under this system.

  4. As the system is complex, there is greater possibility of committing errors and mistakes.

It is clear from the above discussion that the advantages of double entry system far outweigh its disadvantages. So, it is regarded as the best system in the modern world.

 

More study material from this topic:

 Analysis of Business Transaction
 Double Entry System
 Single Entry System
 Difference Between Double Entry System and Single Entry System
 What is An Account?
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Financial Accounting Topics


  Introduction to Accounting
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  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
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  Activity Based Costing System
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 
 

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