Double-entry bookkeeping is an accounting technique that records a debit and credit for each financial transaction occurring within a company. It is seen clearly through the use of a T-account or through the accounting equation – assets equal liabilities plus shareholders’ equity. Double-entry bookkeeping started in Italy but is now used globally. It is important in maintaining an accurate financial system. Companies benefit greatly from using double-entry bookkeeping because it aids in accurate financial reporting and reduces errors and fraudulent activity.
Accuracy – Double-entry booking provides a more accurate look at a company’s financial position than single-entry bookkeeping. One reason for this is because double-entry bookkeeping implements the matching principle. The matching principle uses accrual accounting rules to record revenue and the expenses related to revenue. Recording both revenue and expenses provides an accurate calculation of profits and losses. Profits and losses are represented on the income statement, which includes accounts calculated directly from the entries made in double-entry bookkeeping.
Error Reduction – Human errors can cause a misrepresentation of a company’s financial position. Double-entry bookkeeping reduces errors because it provides checks and balances. With the advancement of technology, many accounting software programs automatically provide double-entry bookkeeping when a transaction is entered. This reduces the chance that a transaction is posted to the wrong offsetting account. Errors are easily caught with double-entry bookkeeping by making sure debit and credit amounts equal. Although errors are greatly reduced with double-entry bookkeeping, it does not totally prevent errors.
Leaves an Audit Trail – Double-entry bookkeeping reduces fraud by leaving an adult trail. An audit trail allows you to trace transactions from the journal entries that were posted to the general ledger. For example, if your cash balance seems too high on your balance sheet, you can trace back the transactions made to the cash account and see if they are accurate. You are able to see the exact accounts affected by posting transactions. Double-entry bookkeeping also uses reference numbers and provides brief descriptions with each entry made.
Financial Statement Preparation – Financial statements are easily prepared in companies using double-entry bookkeeping because information is gathered directly from the double-entry bookkeeping transactions. It is important for companies to produce accurate financial statements quickly and efficiently. Internal users, such as management, depend on financial statements to assess where the company is financially and to create operational budgets. External users, such as investors and vendors, depend on financial statements to determine a company’s creditworthiness.