Double Entry Accounting
Double-entry accounting is termed “double” because every transaction is recorded in at least two accounts using debits and credits. If you make a debit entry in one account, you must make a credit entry in another. The total debits and credits must balance or be equal. You can use double-entry accounting when selling a product or service on credit. The customer receives the product or service now and pays later.
Double Entry Accounting
Double-entry accounting is also known as dual-entry accounting. The fundamental principle of double-entry accounting is that assets = liabilities + equity. If assets increase, either liabilities or equity must also increase.
Sales made on credit are recorded on both the income statement and the company’s balance sheet. On the income statement, the sale is recorded as an increase in sales revenue and cost of goods sold and possibly expenses. The sale is recorded on the balance sheet as an increase in accounts receivable, with a decrease in inventory. The change in equity is reported as the amount of net income earned. In principle, this transaction should be recorded when the customer takes possession of the goods and assumes ownership.
Five Types of Accounts
You must record information from five types of accounts when doing double-entry accounting: asset accounts, liability accounts, equity accounts, expense accounts, and revenue accounts.
Asset accounts record the value of the company’s assets. Liability accounts track the debts owed by the business. Equity, also known as the book value of the business, is the value of assets minus liabilities. Revenue accounts record the money coming into the business, including customer purchases. Expense accounts record what the company has spent money on, such as payroll or inventory.
Practical Example
This example is relevant for small businesses that extend credit to their customers:
You are the accountant for XYZ Clothing Store. A customer shopped at your store and purchased the following items:
– 3 pairs of socks for a total of $12.00
– 2 men’s shirts for a total of $55.00
The total sales amount to $67.00. Your state sales tax is 6% amounting to $4.02 in sales tax. The total sales amount is $71.02. The customer has an account at your store and plans to purchase these goods on credit. Here is the accounting entry you will make, ideally using your computer accounting software, to record the transaction in the journal.
You will enter this information in two places. First, you will enter the data in your sales journal. Second, you will enter the data in the customer’s account. The entry in the customer’s account should look like this:
(Today’s date) Clothing – Sales receipt $71.02
The sales journal entry will use three numbers – total sales, total sales, and sales tax. Here’s how the entry looks:
Sales Journal Entry – Credit Receipt for (Today’s date)
Debit Credit
Accounts Receivable $71.02 Sales $67.00 Sales Tax Payable $4.02
Credit Terms
When businesses offer credit to a customer, it carries a certain time frame within which the bill or sale amount must be paid, for example, 30 days. The company may also offer a discount if payment is made within a shorter time frame, for example, 10 days.
Sale on Credit
A sale is recorded when the risks and rewards associated with the product are transferred to the buyers, leading to income and assets. Income must be credited, and assets such as inventory must be recorded. Of course, sales on credit always involve the risk of the buyer not paying what they owe when due. This leads to bad debt costs, which are estimated based on the buyer’s creditworthiness and the company’s previous experience with that customer and credit sales.
Questions
Repeating
What is the golden rule of double-entry accounting?
The golden rule of double-entry accounting is that assets = liabilities + equity. Both sides of the equation must always be balanced.
What are the responsibilities of an accountant?
Accountants are responsible for recording and maintaining financial transactions, processing payments, gathering financial data, creating financial reports, and managing business records so that the accountant can use them during tax season.
Source: https://www.thebalance.com/how-to-handle-double-entry-bookkeeping-5193897
Source: https://www.thebalancemoney.com/example-of-a-bookkeeping-entry-when-selling-on-credit-392970
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