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Contents:
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Definition and explanation.
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Successive process of the double entry system.
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Advantages.
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Disadvantages.
Every
business transaction causes at least two changes in
the financial position of a business concern at the
same time - hence, both the changes must be recorded
in the books of accounts. This concept is explained
on
Analysis of Business Transaction
page. Otherwise, the books of accounts will remain
incomplete and the result ascertained therefore will
be inaccurate. For example, we buy machinery for
$100,000. Obviously, it is a business transaction.
It has brought two changes - machinery increases by
$100,000 and cash decreases by an equal amount.
While recording this transaction in the books of
accounts, both the changes must be recorded. In
accounting language these two changes are termed as
"a debit change" and "a credit change" The detail
about these terms is given under the topic
account.
Thus we see that for every transaction there will be
two entries - one debit entry and another credit
entry. For each debit there will be a corresponding
credit entry of an equal amount. Conversely, for
every credit entry there will be a corresponding
debit entry of an equal amount. So, the system under
which both the changes in a transaction are recorded
together - one change is debited, while the other
change is credited with an equal amount - is known
as double entry system.
Locus
Pacioli, an Italian wrote a first book on double
entry system in 1494. It is regarded as the best and
the only scientific method of accounting system
universally accepted throughout the world. It has
been built on well defined rules and principles
which is the foundation of modern accountancy.
The
fundamental principle of double entry system lies in
analyzing the two changes (parties) involved in
business transactions and properly recording of both
the changes in the books of accounts. There is no
exception to this principle. If a complete picture
of the transactions is to be reflected through books
of accounts, the double entry system must be duly
observed. Otherwise the books of accounts will fail to provided complete information and the very
objective of accounting will be defeated.
Following are the successive processes of the double
entry system:
Journal:
First
of all, transactions are recorded in a book known as
journal. Read more about
journal.
Ledger:
In the
second process, the transactions are classified in a
suitable manner and recorded in another book known
as ledger. Read more about
ledger.
Trial Balance:
In the
third process, the arithmetical accuracy of the
books of account is tested by means of trial
balance. Read more about
trial balance.
Final Accounts:
In the
fourth and final process the result of the full
year's working is determined through final accounts.
Double
entry system is acknowledged as the best method of
accounting in the modern world. Following are the main
advantages of double entry system:
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Under this method both the aspects of each and
every transaction are recorded. So it is
possible to keep complete account.
-
Since both the aspects of a transaction are
recorded, for each debit there must be a
corresponding credit of an equal amount.
Therefore, total debits must be equal to total
credits. In fact, it is possible to verify the
arithmetical accuracy of the books of accounts
by ascertaining whether the two sides become
equal or not through a process known as
trial balance.
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Under this system
profit and loss account can be
prepared easily by taking together all the
accounts relating to income or revenue and
expenses or losses and thereby the result of the
business can be ascertained.
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A
balance sheet can be prepared by taking together
all the accounts relating to assets and
liabilities and thereby the financial position
of the business can be assessed.
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Under this system mistakes and deflections can
be detected - this exerts a moral pressure on
the accountant and his staff.
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Under this system necessary statistics are
easily available so that the management can take
appropriate decision and run the business
efficiently.
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All the necessary details about a transaction
can be obtained quickly and easily.
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The total amount owed by debtors and the total
amount owed to creditors can be ascertained
easily.
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Sale, purchase of goods, stock, revenue,
expenses and profit or loss of different years
can be compared and the success or failure of
the business measured. Thereafter the causes of
failure can be found out and necessary remedial
measures taken to ensure success of the
business.
Despite so may advantages of the system, double
entry system has some disadvantages which are as
follows:
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Under this method each transaction is recorded
in books in two stages (journal and ledger) and
two sides (debit and credit). This results in
increase of number and size of books of account
and creation of complications.
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It
involves time, labor and money. So it is not
possible for small concerns to keep accounts
under this system.
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It
requires expert knowledge to keep accounts under
this system.
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As
the system is complex, there is greater
possibility of committing errors and mistakes.
It is
clear from the above discussion that the advantages
of double entry system far outweigh its
disadvantages. So, it is regarded as the best system
in the modern world.
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