Using the double-entry bookkeeping method, business transactions are recorded with at least one debit (dr – debit record) and one credit (cr –credit record). More accounts can be used, but total debits must equal total credits to balance the transaction. Debit and credit account names can be customized to meet the needs of each business. A Chart of Accounts (COA) must be created to track these accounts in an organized way.
Double-entry bookkeeping is the most common accounting method used by U.S. businesses and generates the most informative financial statements. This method was originally used by recording numbers on paper ledgers. A debit required an entry on the left side of an account and a credit referred to an entry on the right side of an account. This process evolved over time, but the basic tenets remain the same today. Computer software has enabled double-entry bookkeeping to occur behind the scenes, so it’s not always apparent which accounts are involved in a transaction.
The Chart of Accounts is simply a list of assets (items of value), liabilities (debt owed), income (sales, service), expenses (supplies, payroll) and equity (owner investment, owner drawing) accounts. The following is an example of a Chart of Accounts with debit and credit classifications noted. With double-entry bookkeeping, it is important to understand what is required to increase or decrease the balance of an account, based on recording a transaction as a debit or credit.
Chart of Accounts
Asset |
To increase balance |
To decrease balance |
Cash | Debit | Credit |
Accounts Receivable | Debit | Credit |
Liability |
||
Accounts Payable | Credit | Debit |
Auto Loan Payable | Credit | Debit |
Equity |
||
Owner Investment | Credit | Debit |
Owner Drawing | Debit | Credit |
Income |
||
Sales | Credit | Debit |
Service | Credit | Debit |
Expenses |
||
Supplies | Debit | Credit |
Payroll | Debit | Credit |
Utilities | Debit | Credit |
Based on this example, if the business uses cash to purchase supplies, the Cash asset account would be credited (decreased) and the Supplies expense account would be debited (increased). The business reduced the cash available and generated a greater supplies expense.
Using the double-entry bookkeeping method, business owners can generate reports that provide a more complete financial picture of their business, including determining net worth. The formula to calculate net worth is Assets = Liabilities + Owner Equity and is only possible using the double-entry method of bookkeeping.
This content is provided by Patriot Software, Inc., developer of online small business software for U.S. employers, including online payroll software, time and attendance software, applicant tracking software, human resources software and an employee portal. The company also offers an optional payroll tax filing service for payroll customers. For more information, visit www.PatriotSoftware.com.