Discuss the principle of Double Entry in Accounting
Double entry system of bookkeeping is a method of recording business transactions based on a set of rules formulated for recording financial transactions. In this methodical system, every transaction has two impacts i.e. Debit and Credit. And the rule states that “for every debit, there is credit and for every credit, there is debit”. For every value given there is a receiver of such value.
Every transaction has two effects. For example, if someone purchase a bag of rice from a super market, he pays cash to the cashier and in return, he gets the bag of rice. This simple transaction has two effects from the perspective of both, the buyer as well as the seller. The buyer’s cash balance would decrease by the amount of the cost of purchase while on the other hand he will acquire a bag of rice. Conversely, the seller will be one bag of rice short though his cash balance would increase by the price of the one bag of rice
Accounting attempts to record both effects of a transaction or event on the entity’s financial statements. This is the application of double entry concept. Without applying double entry concept, accounting records would only reflect a partial view of the company’s affairs. Imagine if an entity purchased a machine during a year, but the accounting records do not show whether the machine was purchased for cash or on credit. Perhaps the machine was bought in exchange of another machine. Such information can only be gained from accounting records if both effects of a transaction are accounted for.
Traditionally, the two effects of an accounting entry are known as Debit (Dr) and Credit (Cr). Accounting system is based on the principal that for every Debit entry, there will always be an equal Credit entry. This is known as the Duality Principal.
Features of double entry
There is dual aspect in every transaction:
• Account is to be divided into two specific parts:
There are books of original account as journal and subsidiary against which the ledger account is to be placed. The left side is taken as debit while right side can be taken as credit.
This amount column is specifically divided into Debit side and Credit side. There is column for amount on the debit side as well as amount on credit side.
Date Particulars Amount(debit) Date Particulars Amount(credit)
Advantages of Double Entry System:
There are certain specific advantages that are associated with this system of accounting which ensures that every detail available can be used for further compilation of financial details.
• Detailed information of the records:
Information recorded are detailed for quick reference as well as for preparation of final accounts. Since business deals are associated with assets, expenses, revenue, capital and liabilities on a greater note, hence with help of this system a detailed note can be maintained, which can also act as a reliable fallback option in case of any discrepancy.
• Complete details of profit and loss:
Double entry concept is a very helpful concept. The Trading Account can be formed which is associated with deriving the gross profit and loss amount. Also, with Profit and Loss account that is framed with help of this system, net profit or loss that an organization has incurred can also be seen.
• Detailed knowledge of assets and liabilities:
The Balance Sheet that is prepared helps in segregating assets and liabilities and keeping track of the company’s financial position, and this is gotten from double entry system.
Since there is a detailed description of assets and liabilities as well as profit and losses incurred by a company, hence chances of any unaccounted income or expenditure can be immediately brought to notice.
• Comparative studies:
With the help of a Balance Sheet that is prepared with double-entry system, financial statements can be both compared on an annual basis as well as comparative analysis of actual performance obtained against desired performance.
Disadvantages of Double Entry System:
These are certain areas which do not have any solution when double entry system is being used.
• Errors of principle:
Since this system is specifically associated with balancing credit and debit side, hence it does not have capacity to check out discrepancies when cash sales account is being debited from cash account.
• Errors of omission:
If the recording is not available in the book, then it is very difficult to find out errors.
• Compensation of errors:
Since this system is based on equating of credit with debit accounts, it may so happen that when a particular account is credited with a certain amount of money, another account is debited for the same amount. This will not affect the double entry balancing but still will not make it accurate.