Double-Entry Accounting – A Place to Start

by John Day

Perhaps you are an owner or manager of a small business and have been thinking that it would be a good idea to know more about how accounting works? If so, you are not alone. There are probably thousands of other small business owners/managers in the same boat.

Chances are, you already know quite a bit about accounting since you have to compile financial statements, at least annually, to prepare your income tax returns. I would venture to say that you may only be missing certain key elements of accounting knowledge that prevent you from seeing what accountants call "the big picture."

The first step to take when learning accounting concepts is to set aside your pre-conceptions of what that experience will be like. You need to know that each accounting concept is simple and uncomplicated, like 2+2=4. Combining these concepts into various systems is what constitutes "accounting." Therefore, it is important to fully understand each concept before moving on to the next. This is called "step-by-step" learning.

Let's start with the basics. When we are talking about financial statements, we are referring to a Balance Sheet and a Profit and Loss Statement. As you may already know, these two reports are made up of only five sections. The Balance Sheet has three sections: Assets, Liabilities, and Equity. The Profit and Loss Statement has two sections: Income and Expense. Each of these sections includes particular accounts, whereby all the transactions that occur within the business are accumulated. These accounts are called general ledger accounts.

A ledger is nothing more than a page with a line drawn down the middle. Therefore, the page is said to have a left side and a right side. Entries made to a particular ledger page are recorded on either side depending on their nature. The rule governing this process is called, "The Accounting Equation," and it is stated as:

ASSETS = LIABILITIES + EQUITY

This is not mysterious at all if you have ever purchased a home. Let's say you bought your home for $150,000. You took $50,000 out of your personal savings and made the down payment. You borrowed the remaining $100,000 from the bank. Sounds familiar doesn't it? Apply this information to the "Accounting Equation":

Asset ($150,000) = Liabilities ($100,000) + Equity ($50,000)

Now you could switch things around and say:

Assets ($150,000) - Liabilities ($100,000) = Equity ($50,000)

But it is all the same. For instance, 2+2=4 or 4-2=2.

This is a key concept in accounting because this is why a Balance Sheet has to balance. This is known as "Double-Entry" accounting. Here is the reason:

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