The classic joke amongst accountants is that “Accountants never retire they just become unbalanced”. I say joke – as a comedian I make a very good accountant.
Jokes aside the whole system of accounting is based upon a system of double entry bookkeeping where for every debit there is a credit meaning that the books always balance.
It’s a neat, tidy and ordered method that has been around for many centuries and was first documented by Luca Pacioli, a Franciscan friar, in 1494.
If you’re still awake at this point I’ll briefly explain the system which is based on a simple set of rules. Once you remember and understand the rules you will become a double entry wizard! Your language will change and you will start speaking in debits and credits.
Accountants and bookkeepers like to keep this a secret but double entry is no more than a simple equation.
The Accounting Equation
Very simply the accounting equation is that:
Assets less Liabilities equals Owner’s Equity
Sound simple but there is a bit more to it than that.
Five categories of transactions
To start with we have to identify and explain the five categories of all things accounting.
Income – amounts received for work done or products sold
Costs – outlays for goods and services needed for the business
Assets – things the business owns
Liabilities – amounts the business owes to others
Capital – how much is owed to the owners of the business
All transactions fit into these categories.
Why is it double entry?
Making two entries (known as double entry) means that things must balance. This reduces errors in the accounting records although it doesn’t entirely eliminate them.
What do I debit and what do I credit
There’s no great secret to what to debit and what to credit when keeping your books. It’s merely a matter of following a set of rules for each of the five categories.
All you need to do is have this crib sheet to hand or memorise the rules if you’re good at that type of thing.
Then you just apply The Rules to everything.
You buy a train ticket paying for it from your business bank account
Debit Travel and Credit Business Bank Account
It’s an increase in a cost, in this case travel, and a decrease in the funds in the business bank account (asset).
You sell some consultancy at £200 with the customer paying into the business bank account
Debit business bank account and Credit Sales
It’s an increase to the business bank account (asset) and an increase to income.
You buy some stamps from your own funds.
For a sole trader the entries would be Debit Postage and Stationery and Credit Capital Account
For a Director of a Limited Company the entries would be Debit Postage and Stationery and Credit Director’s Current Account
Obviously certain transactions can get a little more double entry challenging. However the same basic rules apply to every single transaction that your business will make.
And that’s all there is to double entry bookkeeping! Simple!